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Warning: Avoid SNC-Lavalin’s (TSX:SNC) Stock at All Costs

When a stock gets beaten up, value investors start circling. I would caution investors not to fall into a value trap, however. There are times when a company is cheap because there are some significant underlying issues. Case in point: SNC-Lavalin (TSX:SNC).

SNC-Lavalin’s legal struggles have been well documented. It has not helped the company that its bribery issues was at the heart of a Canadian government scandal. Any hopes of securing a deal with the Feds have therefore been greatly reduced.

Last week SNC-Lavalin released  first-quarter results. The market did not react well, sending its share price crashing. Since releasing earnings, the company has lost 11% of its value. The company entered oversold territory and it is starting to look attractive from a numbers perspective. Year to date, it is down 36% and its value has been halved over the past year. SNC’s share price has hit a 10-year low.

Does this make it a good buy? Let’s take a look.

First-quarter earnings

It wasn’t pretty. Last Wednesday, SNC-Lavalin reported a 73% earnings drop and revenue dropping to $2.36 billion from $2.43 billion last year. Adjusted earnings per share came in at $0.21 per share, thereby missing analysts’ estimates by $0.12 per share. Cash flow was negative, and its main unit posted a surprise loss of $0.10 as compared to a profit of $0.44 per share a year ago.

Management was “disappointed” with first-quarter results — and who wouldn’t be? The company is facing a hit to their brand and it is losing out on key contracts. In the fourth quarter, SNC-Lavalin said it lost out on $5 billion in contracts due to the overhang of its Canadian legal battles. It recently pulled out of Saudi Arabia, a key growth market and is in a contract dispute with a mining company in Chile.

The hits keep coming. Along with first-quarter results, the company announced it will be pulling out of 15 countries. Siting unprofitable and sub-scale operations, the company is instead focusing on “work in infrastructure and oil and gas only in our core regions where we have strong capabilities.”

It also announced that it will no longer bid on fixed pricing contracts in the mining industry.

Too much uncertainty

SNC is starting to look cheap on a number of metrics. It is trading at a significant historical discount to sales and book value with a cheap forward price-to-earnings of 10.99 and is undertaking a significant cost cutting program. It has a healthy backlog of projects worth $15.8 billion and despite negativity booked $3.2 billion in new projects in the first quarter. It also reiterated full-year adjusted earnings per share of $3.10 at the mid-range of guidance.

The reality however, is that there is too much uncertainty. Each quarter brings along with it more bad news. Only a few months ago, the company was a Dividend Aristocrat. It has since cut its dividend.

It was also growing at a double-digit pace, and has since been forced to pull out of its highest-growth market (Saudi Arabia). Its credit rating has been dropped to BBB and is at risk of being blocked from bidding on federal contracts. If that weren’t enough, a conviction on bribery charges could spell trouble for existing contracts. Analysts estimate that Canadian federal contracts account for approximately 50% of its current backlog.

It may seem cheap today, and there are times when it pays to be a contrarian investor. The risk however, is too high with SNC-Lavalin.

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Fool contributor mlitalien has no position in any of the stocks mentioned.

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