Waiting for a recovery in the residential building materials industry is like waiting for the second coming of Christ. Some have given up hope and others think it will happen but are clueless about the timing.
That said, an interesting catalyst can be identified at the building materials outfit Alesco Corp, the owner of B&D garage doors. The sale of the group's decorative surfaces business for about $4 million would hardly be worth looking at, but it may prove to be profitable.
The company said the division would be responsible for a $7 million loss in earnings before interest and tax (EBIT) for this year. Given Alesco is only forecast to earn $25 million for the period, this is effectively a 28 per cent upgrade to EBIT for next year, all else remaining equal.
This year's accounts will look terrible, with the company taking a hit on the book value of the decorative surfaces division however, it will make next year's earnings look considerably better. If, in addition, there is a slight pick-up in the residential building market, it is conceivable that Alesco could report a net profit of $20 million and an EBIT figure of $35 million next year. This would put it on a price-earnings ratio of about 7.5 times, which makes it attractive in a bottom of the cycle period.
The sale of the decorative surfaces unit has sparked some interest, with the stock jumping in recent weeks, but the potential is there for further upside.
HIDDEN VALUE
Is Harvey Norman a deep-value buy or a value trap? The net tangible assets, predominantly real estate, are valued at $2.30 a share, while the share price is limping along at $1.95. Deep-value investors argue that you get the retail business for free if the property assets are sold and the money is handed back to shareholders. The other big hidden asset in the company is about $600 million of franking credits that would allow the group to pay a franked dividend of about $1.5 billion.
The decision on how to realise value from the company rests with the founder and 50 per cent shareholder, Gerry Harvey. Harvey has always been dismissive of selling the property and trying to pay the franking credits out. He has been wary of having a landlord to answer to. But with structural and cyclical change at play in the retail market, it is possible Harvey and his board members are starting to look at how to realise some of the deep value in the company.
For the moment, he and his team will concentrate on trying to improve operational performance rather than capital management. The changes will see electronics and computers receive reduced floor space, and they will be replaced by white goods and bedding. This means Harvey Norman will become more of a play on a housing pick-up rather than a general retailer.
If this operational overhaul fails to deliver value, Harvey has indicated he will have to look at releasing some of the value that lies within the company.
BIOTECH STAR
Investing in biotech stocks is a white-knuckle ride. The rare winner delivers enormous returns, and investors who got into the drug delivery group Acrux a few years ago have watched their investments more than double. Unlike most other life science plays, Acrux has a product in the market and is earning revenue. The question now is what will drive the share price higher from here. A patent extension in the US could be the trigger, but first a recap.
After receiving approval for its Axiron testosterone therapy, Acrux signed Eli Lilly to distribute the product. Launched in the US last April, Axiron has grabbed 13 per cent of the market, and this share is rising rapidly. The product treats men, mainly of middle age, for a lack of testosterone through a spray or gel applied under the arm. Its main rival, AndroGel, which has more than 60 per cent of the market, has a more invasive application where the user has to lather the top half of his body using the gel, and then sit in isolation for the next hour or so.
The market for what is usually referred to as "Grumpy Old Man Syndrome" is about $1.5 billion a year in the US alone, and is growing at an increasing rate, hitting 30 per cent this quarter.
Acrux has a market capitalisation of $660 million, and net cash of about $28 million on its balance sheet. The company receives a royalty from Eli Lilly and milestone payments over the life of the drug.
The US patent runs out in 2017. However, the company is pushing for a nine-year extension and hopes to receive some good news soon. If the patent extension fails to materialise, there will be a disappointing response. An extension, however, could easily add more than a dollar to the share price.
The Sydney Morning Herald accepts no responsibility for stock recommendations. Readers should contact a licensed financial adviser.
Frequently Asked Questions about this Article…
What did Alesco sell and how will the disposal affect Alesco's earnings?
Alesco sold its decorative surfaces business for about $4 million. The division is expected to be responsible for a $7 million EBIT loss this year, so disposing of it effectively improves next year’s earnings outlook — the article says this equates to roughly a 28% upgrade to forecast EBIT (given Alesco is forecast to earn $25 million for the period).
Could Alesco become more attractively valued after the disposal?
Yes. The piece suggests that if there’s even a slight pick-up in the residential building market, Alesco could report about $20 million net profit and $35 million EBIT next year, which would put it on a price‑earnings ratio of roughly 7.5 times — making it look attractive in a bottom‑of‑cycle period. The stock has already risen in recent weeks on the news, and there may be further upside.
What are the main risks investors should know about Alesco right now?
Short‑term accounts will look worse because the company must take a hit to the book value of the decorative surfaces unit this year. Also, a meaningful improvement depends partly on a recovery in the residential building market — if that recovery doesn't materialise, upside will be limited.
Is Harvey Norman a deep‑value buy or a value trap based on the article?
The article highlights a debate: Harvey Norman’s net tangible assets (mostly real estate) are valued at about $2.30 a share while the share price was around $1.95, suggesting deep‑value potential. There are also roughly $600 million of franking credits that could support a large franked dividend. However, founder Gerry Harvey (50% shareholder) has been reluctant to sell property or return capital, so whether value is realised depends on management decisions — meaning it could be either a buy or a trap depending on outcomes.
How is Harvey Norman changing its store strategy and why does that matter to investors?
Harvey Norman is reducing floor space for electronics and computers and replacing it with more white goods and bedding. That shifts the business to be more of a play on a housing market pick‑up rather than a general retailer. For investors, that means performance will be more tied to housing and appliance demand than broader retail trends.
What hidden value exists in Harvey Norman and what could unlock it?
Hidden value includes real estate (NTA about $2.30 per share) and around $600 million in franking credits that could support roughly $1.5 billion of franked dividends. Unlocking that value would require management to sell property or otherwise change capital management policy — something the founder has historically resisted, although he has indicated he may consider releasing value if operational changes don’t deliver.
Why is Acrux considered an interesting biotech stock in the article?
Acrux has a commercial product, Axiron (a testosterone therapy), which is distributed in the US by Eli Lilly. Axiron grabbed about 13% of the US market after launching and that market is roughly $1.5 billion a year and growing rapidly (the article notes 30% growth this quarter). Acrux receives royalties and milestone payments, and has a market capitalisation of about $660 million with roughly $28 million net cash — all factors cited as attractive for investors.
What are the key upside catalysts and risks for Acrux investors?
The main upside catalyst is a potential US patent extension: the current US patent runs out in 2017 and Acrux is seeking a nine‑year extension; a successful extension could add more than a dollar to the share price according to the article. The key risk is that if the extension fails to materialise, the share price could react disappointingly despite current gains from Axiron’s market uptake.
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