The Australian stockmarket has experienced a mild correction over the past two months but for many smaller industrial stocks it has been a rout. Mark Beyer goes looking for value.
The Australian stockmarket has experienced a mild correction over the past two months but for many smaller industrial stocks it has been a rout. Mark Beyer goes looking for value.
What goes up must come down. That has been the story for many mid-cap industrial stocks in Western Australia this year.
The likes of Schaffer Corporation, Kresta and Fleetwood Corporation have been star performers over the past few years but in 2005 they have come to a shuddering halt.
Or more precisely a crunching fall.
The sell-off of mid-cap stocks has far outstripped the overall market correction.
The All Ordinaries index, which tracks the top 500 stocks, is about five per cent below its March peak, driven lower by the slowdown in the domestic economy and increasing cost pressures, including higher oil prices and higher interest rates.
Investors have turned to ‘defensive’ stocks with a high degree of earnings certainty, and as a result mid-cap stocks have been hit particularly hard.
Macquarie Equities noted in a recent report that the price of mid-cap stocks had risen to a point where the sector’s price earnings multiple was in line with the top 100 stocks for the first time since 1994.
In other words, investors were not pricing in a risk premium for mid-cap stocks. That has quickly changed, fuelled by more than 110 earnings downgrades.
Patersons Securities has found a silver lining to the dark cloud.
“Small caps, as a whole, are likely to keep suffering in the short term,” it said in a recent research note.
“As investors run towards defensive blue chips, however, there has been little discrimination in the small cap sell down, opening up several value opportunities.”
Coventry Group is a classic example of a stock that has been heavily sold because it is in the wrong sector; ie automotive supplies.
Patersons believes it has been oversold, as it supplies the relatively stable aftermarket – not vehicle sales – and is supported by strong trade relationships.
It also has an industrial supplies business that benefits from the booming resources sector.
Macquarie also backs Coventry, based on “numerous opportunities to improve margins”.
“We believe Coventry has a number of hidden assets and has been managed conservatively for a number of years.”
Patersons says that cyclical stocks should not be viewed as a single group, and that companies with strong exposure to the resources sector or the relatively buoyant WA economy do not follow the one ‘domestic economy’ cycle.
Companies in this camp include drilling firm Ausdrill and scaffolding supplier PCH Group, which are enjoying strong demand for their services and have capacity to pass on higher costs to their customers.
Bell Potter Securities’ analyst Matthew Ward said many of the mid-cap industrial stocks to have been sold off this year were highly cyclical.
He believes the key to finding value is to focus on companies with quality management and a good track record for managing risk.
He also likes stocks that have a relatively large portion of recurring revenue, such as from long term service contracts, and exposure to resource and infrastructure development projects.
Engineering services firm Mondadelphous fits the bill on all counts and is one of Mr Ward’s preferred stocks among WA industrials.
He adds that many of Monadelphous’ contracts are delivered on a cost-plus basis, which allows cost increases to be passed on.
Mr Ward also likes the look of IBT Education, which he believes was oversold.
It was one of the first companies to downgrade its earnings forecast early this year, just a few months after floating.
Mr Ward believes the market over-reacted and failed to appreciate the company’s strengths, including its long term contracts, strong cash flow and low capital spending requirements.
He put a Buy recommendation on IBT when it was trading at $1.44 and it is now near to his price target of $1.73.
Patersons also likes IBT, which it says has a relatively defensive earnings outlook.
The attractions include a discount to valuation, strong management, a dominant brand in an untapped market and a track record of increasing earnings.
Another ‘defensive’ stock winning friends is internet services company iiNet, which completed its biggest purchase this year.
Macquarie believes the Ozemail purchase is a potential company-making event for iiNet, as it will rapidly achieve sufficient scale on the east coast to fast-track its network infrastructure rollout.
Patersons believes the upside from the Ozemail deal and new product offerings is not being factored into iiNet’s share price.
Other mid-cap stocks in favour with brokers include boat builder Austal, which recently announced further sales orders, and labour hire and training firm Integrated, which has completed a year of rapid growth.
Company founder Jon Whittle, who has announced plans to retire, confirmed this month the company will report a profit “largely in line with forecasts and market conditions”.
“IGL’s current share price is a poor reflection of fundamental value in the company now and going forward,” Mr Whittle said.
Manufacturing companies Fleetwood and Kresta illustrate two of the major issues facing mid-cap stocks - rising costs and the shortage of skilled labour.
Fleetwood said early this month that underlying profit in 2005 but would be about the same as in 2004, which the market interpreted as a downgrade.
Some of the factors affecting its performance include the rationalisation of its manufacturing facilities, labour shortages in Victoria and delays and cost pressures on some projects.
This news sent the share price as low as $5.80 – it has since bounced to around $6.30 but is well below the $8.50 level that prevailed early this year.
Mr Ward believes Fleetwood has been oversold and rates it as a buy.
Kresta has been hammered even harder after issuing two profit downgrades, with the latest saying profit would be down 40 per cent.
It said sales were expected to grow 11 per cent but it would be adversely affected by delays in consolidating its manufacturing operations, a shortage of skilled labour and rising materials costs.
Kresta is currently trading around 26 cents, down from about 60 cents at the start of the year. Engineering services firm Mondadelphous fits the bill and is one of Mr Ward’s preferred stocks among WA industrials. He adds that many of Monadelphous’ contracts are delivered on a cost-plus basis, which allows cost increases to be passed on.
Mr Ward also likes the look of IBT Education, which he believes was oversold.
It was one of the first companies to downgrade its earnings forecast early this year, just a few months after floating.
Mr Ward believes the market over-reacted and failed to appreciate the company’s strengths, including its long term contracts, strong cash flow and low capital spending requirements.
He put a Buy recommendation on IBT when it was trading at $1.44 and it is now near to his price target of $1.73.
Patersons also likes IBT, which it says has a relatively defensive earnings outlook.
The attractions include a discount to valuation, strong management, a dominant brand in an untapped market and a track record of increasing earnings.
Another ‘defensive’ stock winning friends is internet services company iiNet, which completed its biggest purchase this year.
Macquarie believes the Ozemail purchase is a potential company-making event for iiNet, as it will rapidly achieve sufficient scale on the east coast to fast-track its network infrastructure rollout.
Patersons believes the upside from the Ozemail deal and new product offerings is not being factored into iiNet’s share price.
Other mid-cap stocks in favour with brokers include boat builder Austal, which recently announced further sales orders, and labour hire and training firm Integrated, which has completed a year of rapid growth.
Company founder Jon Whittle, who has announced plans to retire, confirmed this month the company will report a profit “largely in line with forecasts and market conditions”.
“IGL’s current share price is a poor reflection of fundamental value in the company now and going forward,” Mr Whittle said.
Manufacturing companies Fleetwood and Kresta illustrate two of the major issues facing mid-cap stocks - rising costs and the shortage of skilled labour.
Fleetwood said early this month that underlying profit in 2005 would be about the same as in 2004, which the market interpreted as a downgrade.
Some of the factors affecting its performance include the rationalisation of its manufacturing facilities, labour shortages in Victoria and delays and cost pressures on some projects.
This news sent the share price as low as $5.80 – it has since bounced to around $6.30 but is well below the $8.50 level that prevailed early this year.
Mr Ward believes Fleetwood has been oversold and rates it as a buy.
Kresta has been hammered even harder after issuing two profit downgrades, with the latest saying profit would be down 40 per cent.
It said sales were expected to grow 11 per cent but it would be adversely affected by delays in consolidating its manufacturing operations, a shortage of skilled labour and rising materials costs.
Kresta is currently trading around 26 cents, down from about 60 cents at the start of the year.
PREFERRED MID-CAP STOCKS
PATERSONS
Ausdrill
Coventry
IBT Education
iiNet
Integrated
PCH Group
MACQUARIE
Austal
Coventry
IiNet
Integrated
BELL POTTER
Fleetwood
Great Southern
IBT Education
Monadelphous
