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The FTSE 250 has rallied 6% over the past year, with several stocks posting fresh 52-week highs over the past month. Yet not all constituents have done that well. For example, WH Smith (LSE:SMWH) is down 33% in the past six months, hitting fresh multi-year lows in August. Here’s why I’m interested.
Reasons for underperformance
Let’s begin by considering why the stock has lagged the broader index so much. The most direct catalyst was the recent discovery that its North America business had overstated trading profits by £30m. This was due to premature recognition of supplier income, forcing the company to slash its profit forecast and trigger a full review. That alone drove the share price down over 30% in a single day in August, eroding investor trust.
Besides this, the struggle with high street stores and the legacy business model hasn’t helped. It has been shrinking then offloading its UK high street stores for some time. This is due to sales falling and profitability deteriorating. Even within the stores, key product lines like print media, stationery and newspapers remain in long-term decline because of digital alternatives.
Why it could be good value
Although the accounting blunder isn’t a good look, it’s not the end of the world. In fact, it’s a one-off issue that doesn’t reflect the actual fundamental business model. What I mean is that the impact of the error is now fully factored into the current share price. Therefore, I struggle to see it falling further based on this historical factor.
With regard to the stores, the strategic restructuring should start to yield fruit. It’s now concentrating on its travel retail division (stores at airports and railway stations) where competition is lower. At these sites, footfall is often captive, and margins tend to be stronger. In the years to come, the high street exit will reduce its drag on profitability and let management focus on growth in improving the travel retail business.
When I combine the one-off impact of the accounting issue and the positive restructuring outlook ahead, I think the stock is good value. Yet this subjective view can be combined with hard numbers. For example, the price-to-earnings ratio is 7.68. Typically, any stock with a ratio below 10 is considered to be potentially undervalued.
Risks to remember
Over the past year, the share price is down 52%. Clearly, some investors are concerned about the direction going forward. I get this, as there are doubts about management oversight and the accuracy of prior and future financial forecasts. I’d say it’s a high-risk stock, but the valuation is attractive. Therefore, I’m thinking about allocating a small amount of money to the stock. If I’m right and it rebounds in the coming year, fantastic. If it keeps falling, I can look to invest more to lower my average cost. Investors who are comfortable with the risk level might want to consider it too.
This story originally appeared on Motley Fool
