In a new column, former fund manager Matthew Kidman looks for diamonds and dogs in the sharemarket.
COFFEY INTERNATIONAL (COF)
This is a classic turnaround play. A multi-year acquisition spree ran into trouble back in 2010, triggering an overhaul, with John Douglas appointed as CEO. The consultancy and project management company raised funds to repair its balance sheet and, after a strategic review, said it would cut $18 million out of its cost base and discontinue some lines of business. This fell flat with investors with the share price falling from $1 to a low of 36? in October 2011. Since then the stock has found its feet and more than doubled to be sitting at 66?.
Is the rally over? I don't think so. When you are looking at stocks, the key is to find a catalyst that triggers a re-rating. For Coffey, the first catalyst was the change in management and the strategic review. Next was the solid first-half result of $20 million EBITDA and net profit of $2.6 million. Moreover, management commentary about the second half was heart-warming. The company said it expected a full-year EBITDA of $45 million and flagged reduced interest and tax costs in the second half. It is possible the company could clock up a net profit for the current half of somewhere between $8 and $10 million. If you annualise this number, the group is trading only about eight times price to earnings multiple. On that basis the stock could easily rally another 40 per cent.
We should not lose sight of the fact this is a turnaround, which are notoriously risky investments.
BREVILLE GROUP (BRG)
A major positive has taken place for kitchen appliance group Breville. The company's share price has been on a tear, prompting its major shareholder and local competitor GUD Holdings to unload its 19.3 per cent stake. GUD bought its stake back in May 2009 for just 72? and this week offloaded to investors at $3.35.
BRG has succeeded in the United States. Investors should be actively searching for exposure to the US market as the world's biggest economy shows genuine signs of recovering. In BRG's latest half yearly accounts, North American EBIT spiked 82 per cent year on year, easily offsetting the softer and more mature Australian market.
On the back of the US success, BRG could achieve double-digit earnings per share growth for the next three years. With the stock trading on a price earnings multiple of 11, it could see the share price rise up to 30 per cent. The obvious risk is a weak domestic economy and the impact of a raising Australia dollar. Keep a close eye on both of these swing factors.
CAST steel manufacturer and supplier Bradken Limited is in a sweet spot given it supplies and maintains products for the mining and infrastructure industries. Since October last year, the stock price has risen a hefty 25 per cent.
Bradken is a capital-intensive business. To grow its earnings at a rate to satisfy investors, it needs to invest significant funds into the business. In 2012, capital expenditure will be $160 million. This will virtually ensure that there is not free cash flow for the 12 months. In fact, Bradken will burn cash, despite growing its headline profit quite strongly for the year.
The phenomenon of a company not producing cash because of major capital investment is not uncommon. This has the impact of forcing the company to raise capital, either equity or debt, diluting returns not ideal for investors.
Matthew Kidman is a former fund manager, author and director of WAM Capital. This commentary should not be construed as investment advice.