When is the right time to buy shares in a turnaround situation? That’s a hard question to answer, but typically it is before the recovery effort translates into higher reported earnings. By the time we see the numbers in writing, the market will have already priced in better news.

Hotel Chocolat (HOTC:AIM) is the perfect example to study. In July 2022 the chocolate maker nearly halved in value after doling out a mountain of bad news.

It scaled back plans for overseas growth, which had previously been a major opportunity for the group. Investment in the US and Japan was materially reduced, while US stores were closed down to become a digital-only operation.

It’s rare for all the bad news to come in one go, and so we had further setbacks in September with the decision to exit all direct-to-consumer operations in the US. That was followed by what many hoped would be the final ‘kitchen-sinking’ efforts in December when the full-year results included several exceptional costs that related to the reshaping of the group and its strategy.

If you look at the share price chart, Hotel Chocolat started to pick up a few weeks after these results, moving from 140p to 230p (a 64% rise) in just two months as investors took the view all the bad news was in the price. At this stage, hope was still the driving factor, not actual evidence of improvement.

Admittedly that did coincide with a period where investors became happier to buy higher-risk stocks again, in the hope we would see central banks stop raising interest rates. Then came the banking crisis and higher risk shares like Hotel Chocolat went out of favour.

The next trading statement was always going to be a big test. The market wanted reassurance that life was getting better for the business – sadly it wasn’t, and we saw an 11% share price slump on the update.

Without good news to support the shares, many investors will have walked away from the turnaround story at this point, losing patience.

Buying into a turnaround situation is about spotting nuggets of positive information, seeing that change is underway, and that a clear plan to fix things is being executed as promised. You don’t want to buy the shares until there is a succession of good news – but equally leave it too late and you could miss out on the big gains.

Hotel Chocolat was upbeat and optimistic in its half-year results published in March. Less than two months later it issues a profit warning and emphasises that 2023 was always a ‘transition’ year and 2024 is when growth returns.

Pre-tax profit is forecast by Liberum to go from £21.7 million in 2022 to £200,000 in 2023 and magically back to £18.5 million in 2024 and £30.7 million. That looks a tall order.

It’s always better for management to under-promise and over-deliver. If they raise the bar too high, it becomes impossible to hit.

Hotel Chocolat’s latest setback means management has lost credibility with the market again, so it will require significant evidence of improved trading before investors buy back in. Knowing how to read these kinds of scenarios could help you spot the best turnaround opportunities and avoid those where the risks are still too high to get involved.

‹ Previous2023-05-04Next ›