Here’s 1 Cheap Blue Chip Stock That Investors May Want To Worry About

Palm oil and sugar producer Wilmar International Limited (SGX: F34) is a blue chip stock in Singapore’s market by virtue of its status as one of the 30 companies that make up the market barometer, the Straits Times Index  (SGX: ^STI).

It may also be a stock that’s on the radar of bargain-hunters at the moment. That’s because shares of the company are currently at a price that’s near a five-year low, as you can see in Chart 1 below:

Chart 1 - Wilmar's share price since 14 March 2011
Source: S&P Global Market Intelligence

Moreover, Wilmar’s share price is not the only thing that’s at a multi-year low. As the following chart illustrates, a number of the company’s valuation metrics – namely the price-to-sales (PS), price-to-earnings (PE), and price-to-book (PB) ratios – are also near their respective five-year lows.

Chart 2 - Wilmar's PS, PE, and PB ratios since 14 March 2011
Source: S&P Global Market Intelligence

These low valuations may help set the stage for a possible mean reversion to occur, which is the simple idea that what has fallen (or risen) will return back to the average over time. But, it’s important to note that a share need not be a bargain just because it has a low valuation in relation to history. Investor Ric Dillon explains:

“On the behavioural-finance side, one of many inefficiencies comes from people anchoring on the past. People assume something is cheap, say just because it hasn’t traded at such a low valuation for five or ten years. But that doesn’t matter, what matters is what will be.”

There may be reason to worry about the future of Wilmar’s business. In Chart 3, you can see how Wilmar’s returns on equity have steadily declined from a low-teens level in 2010 to merely 6.9% in 2015 even as its net-debt (total borrowings and capital leases net of cash and short-term investments) to equity ratio have remained high at over 75%. This could be a sign of Wilmar’s business having to face deteriorating economics.

Chart 3 - Wilmar's returns on equity and net-debt to equity ratios from 2010 to 2015
Source: S&P Global Market Intelligence

Mean reversion can happen not just to a company’s valuation ratios – it can also happen with a company’s business results itself.

So, there is a chance that what Wilmar has gone through from 2010 to 2015 may be temporary in nature. But if that’s not the case – meaning to say that the economic characteristics of Wilmar’s business have weakened permanently – then even Wilmar’s cheap valuations may not offer much downside protection. This is a risk that current and prospective investors of Wilmar International may want to think about.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn't own shares in any companies mentioned.