A quality dozen showing value

These high-quality stocks have room to grow.

Summary: There are undervalued stocks in any market, but finding the good ones is never easy. Below is a list of 12 stocks that fit the category of good-quality companies that are currently trading below their fair market value.
Key take-out: In finding the undervalued stocks in this list, “quality” has been the primary filter, with “value” the secondary.
Key beneficiaries: General investors. Category: Shares.

Earlier this week we presented to Eureka Report readers a list of 30 stocks where we believe the current dividends are under threat (see Thirty dividend income threats). Today we cast the net into the market and present an examination of a dozen quality stocks that we see are trading at or near fair value.

The context in which this table is presented is interesting. November was the first down month for our local stockmarket market in four months. It’s been a good run, but we lost 1.95% over the last four weeks.

Meanwhile, the $A has taken an absolute hiding – down to US91 cents from US97c in five weeks, and you’d have to say it’s only natural for the market to retreat with it. Nonetheless, the corporate market is hotting up, with the month of December providing 17 IPOs or raisings. Moreover, Dick Smith listed today (December 4) with a solid 8 cent premium to its listing price of $2.30. It will be interesting to see how it performs considering it was a struggling retailer owned by Woolworths not too long ago.

But, for many investors, the quest remains to find good-quality dividend stocks in the market. To throw some light on this challenge, I’ve been working with our quantitative analyst Kien Trinh. We know investors are looking for good stocks near value territory, and we also know that many of the market’s leaders – such as the banks - are fully discovered at this stage

Kien uses two key criteria to find stocks that are likely to outperform the market. He firstly screens companies of high quality and then identifies value among those high-quality companies. “Quality” is the primary filter, with “value” being the secondary.

Once we’ve run the numbers it’s interesting to see how many key stockmarket companies the list throws up. As you will see from reading the table below, we measure several ‘value’ variables’. Among the items we consider are return on equity, gross yield – that is the yield, you the retail investor, actually gets after franking has been considered.

We also take note of price earnings ratios among these stocks. As you might expect, metals and mining is well represented here along with utilities and retailing. An easy way to rank the stocks is in terms of the discount between their actual value today and our estimated fair value.

What does the table reveal? Well, there are at least a dozen quality stocks that are trading below or near fair value.

Retailer JB Hi-Fi ($19.73), which witnessed Dick Smith’s modest debut on the Australian Securities Exchange at noon today, had a closing price of $19.73 yesterday after surging more than 30% over the past six months. Kien still sees an excess return of 22.8% for the stock, with a fair value of $24.33.

Credit Corp Group ($8.59) is part of the Uncapped 100 and is described as a debt purchase and collection company strongly leveraged to any rise in loan defaults. After hitting a record high of $10.79 in September the group was at $8.59 on Tuesday, but that’s a substantial discount to its fair value of $10.20.

Global pharmaceutical company CSL ($68.25) is trading at a 17.7% discount with a fair value of $80.35. Achieving fair value would represent untouched heights for the company’s share price as it reached a record high of $69.50 at the end of October, but its central research into extending the use of blood plasma products is promising.

Spark Infrastructure Group ($1.57), which invests in electricity distribution businesses, is being priced for the worst-case scenarios concerning tax audits and regulatory challenges within South Australia and Victoria. However, Kien puts the group’s fair value at $1.82 – meaning a 15.9% excess return.

Global mining giant BHP ($36.69) is actively working to leverage itself to the resilient iron ore price by increasing spending at the Pilbara. With iron ore being the most profitable part of the business, the miner’s estimated fair value sits at $41.56. BHP closed at $36.69 yesterday.

Envestra ($1.04), as one of Australia’s largest natural gas distribution companies, has significant gas distribution networks and transmission pipelines in regulated monopolies across Victoria, South Australia and Queensland. Its share price sits at around $1.04, but its estimated fair value is 12.1% higher at $1.16.

Like Spark, SP AusNet ($1.14) operates in the electricity distribution space. Kien puts the fair value of the company at $1.27 – an excess return of 11.9% – even as the company deals with a multi-million dollar dispute with the Tax Office. The company boasts impressive revenue growth due to increases in regulated prices, with its revenue coming in 8.7% higher to $961.2 million for the six months to September 30.

Challenger ($5.98), which provides fixed income security for retirees, is well positioned to benefit in the long term from more baby boomers entering retirement and pooling super accounts. It has an estimated fair value of $6.69, representing an excess return of 11.9% on its current share price.

Radio Rental retail chain owner, Thorn Group ($2.22), had slipped to a 1½-month low late last month after announcing its chief executive was retiring and on casting a sombre outlook for the current financial year. However, its estimated fair value is still around $2.45, meaning the stock is trading at a 10.4% discount as of yesterday’s close.

More so than BHP, Rio Tinto ($65.74) is banking on the iron ore price remaining strong, with a growth plan expected to deliver 360 million tonnes of iron ore by 2017, but at only half of the $5.5 billion it was originally tipped to cost. Kien’s estimated fair value for the company is $72.47, which is a 10.2% excess return.

Currently, Westfield Retail Trust’s ($3.05) estimated fair value sits 4.9% above yesterday’s closing share price of $3.05. However, investors need to consider the wider implications of today’s news that the trust will merge with Westfield Group’s Australian portfolio, becoming Scentre Group – the largest real estate investment trust in Australia.

Toll road operator Transurban Group ($6.96) is regarded as being leveraged to the potential recovery in Australia’s east coast economy. It has plans to build on that, having launched a bid for Sydney’s Cross City Tunnel and eyeing Queensland Motorways. With an estimated fair value of $7.19, shares in the company are trading at a 3.4% discount.


This is an extract from the newsletter Premiership Portfolio by Sam Fimis of Paterson Securities available here www.premiershipportfolio.com/. With additional research by quantitative analyst Kien Trinh.

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