Healthy outlook in chosen few

Out of the 14 stocks that I have recommendations for in Eureka Report’s Share Recommendations, I have selected the five companies that I believe are best placed to receive a positive share price catalyst from the full-year results in August.

The criteria of my assessment is:

1. Chances of exceeding FY14 earnings expectations;
2. Outlook for FY15;
3. Upside dividend risk;
4. Quality well managed companies with structural tailwinds;
5. Discount to valuation.

The stocks I have chosen are Azure Healthcare (AZV), Pental (PTL), Empired (EPD), Vita Group (VTG) and Capitol Health (CAJ)

Azure Healthcare (AZV): Azure Healthcare (AZV) captured my attention after an excellent first-half result, with a 240% increase in net profit after tax (NPAT) to $2.2 million. The large jump in profit occurred with a smaller 42% revenue increase, reflecting the benefit to earnings margins from an increasing proportion of software sales.

The full-year result is likely to provide the market with confidence of continued high growth, albeit not at the same rate as the first half.

The company’s success and positive outlook has been driven by executive chairman Robert Grey’s decision to expand from a basic nurse call system manufacturer to a provider of integrated clinical workflow software systems for healthcare facilities.

The “clinical workflow” or software systems for hospitals is growing especially fast in North America. During the financial year the company opened a second manufacture and assembly plant in the US. This will allow growth in the US, Canadian and South American markets, with reduced shipping costs and lead times compared to the existing facility in Australia.

The reason the annual industry growth is likely to keep growing at a rate of at least 20% is that the systems remove manual processes and reduce admission and discharge times. The operational cost savings for hospitals easily justify the upfront investment.

The company has developed significant intellectual property, and has relationships with more than 8000 healthcare providers. This, combined with the fragmented nature of the industry, leads me to believe the tentative takeover approach received in April this year won’t be the last.

On my numbers the company is trading on a FY15 price earnings ratio (PE) of 12, with upside risk to my $0.39 discounted cash flow valuation.

I re-iterate my last Buy recommendation on May 7.

Pental (PTL): Pental Ltd (PTL), the domestic manufacturer of household cleaning products, is a turnaround story that is yet to be appreciated by the market. The full-year result is likely to provide the market with confidence that this is now a stable company that doesn’t deserve to trade on the current deeply discounted earnings multiples.

After only just surviving a perfect storm of headwinds in 2011, the company has closed its chemicals division and re-capitalised the balance sheet. This now positions the company to reinstate its dividend and consider small acquisitions. With a franking balance of more than half the market capitalisation, I am expecting either a dividend at the full-year result or confirmation of when it will return.

Supplying the major supermarkets has many associated risks; however despite all of the recent challenges the company’s brand strength remains strong. Many are leaders in their category and the recent ability to reinvest in the business will improve the performance of brands such as White King, Softly, Pears and Jiffy.

Charlie McLeish begun as CEO at the start of the year, and his 20 years of industry experience is already paying dividends with improved product marketing, packaging and new contracts with suppliers.

The $60 million market cap is less than book value, and the FY15 PE of 9 is very cheap, suggesting the market hasn’t recognised the turnaround effort or ability to grow earnings in future years.

FY14 has very much been a year of stabilisation, setting the company up for growth in FY15 and FY16.

With next to no debt, a new non-restrictive banking relationship and a long list of strategic initiatives my 4.6 cent valuation/price target implies two years of forecast double digit earnings growth despite the poor industry structure.

I reiterate my last Buy recommendation from on May 14.

Empired (EPD): The WA based IT services company has achieved strong growth despite operating in a weak sector that has suffered from a lack of IT spending from governments and large corporates. With a market cap of $60 million, the micro-cap’s management team has long-term ambitions of gaining the same scale of some of its larger listed IT rivals. 

The company has benefited from two key acquisitions and a boosted management team to assist managing director Russell Baskerville from 2012. This now gives the company the ability to win contracts worth greater than $50 million.

While the IT services sector has been weak, there is an underlying level of demand from the need to replace ageing systems. Empired has embraced the new IT world, with more efficient solutions such as its class-leading “Flexscale” cloud computing service. IT services companies increasingly need to be able to justify their value-add up front rather than the old model of supplying consultants at an hourly charge-out rate.

I am confident the company will meet or exceed FY14 expectations, and then locked-in contracts underpin large growth for FY15 with additional upside from a large tender pipeline of potential contracts. The extend of the growth will see the FY14 PE of 30 reduce to an FY15 PE of 9, with further growth forecast for FY16.

The stock has increased 15% since my first recommendation, but I still see further upside once the market looks to the FY15 growth opportunity and discount to my $0.85 valuation.

I reiterate my last Buy recommendation on April 9.

Vita Group (VTG): Vita Group provides the much sought after combination of high yield, high growth and large discount to valuation. I believe the full-year result will demonstrate that the troubles from its Fone Zone, One Zero and Apple Next Byte stores are over, and shareholders can now look forward to the benefits from an optimised store portfolio largely focused on its Telstra stores.

Additional catalysts include a potential capital return, and clearing the stock overhang from ex-CEO David McMahon’s 20% stake. These combine to present a strong buying opportunity.

My forecasts suggest a dividend yield of at least 6%, an FY15 PE of 10, and at least 25% upside to the $0.75 share price. There is shareholder pressure to release franking credits, considering they amount to over half the market cap.

The process of transitioning away from the poorly performing stores is largely complete. The company is now also entering the sweet spot with a large percentage of the Telstra stores in the high-growth phase. After the first two-year ramp-up period the company owned and managed Telstra stores typically achieve the highest growth in the third and fourth year of operation.

I reiterate my last Buy recommendation from June 18.

Capitol Health (CAJ): Capitol Health has grown to become the largest community based (non-hospital) diagnostic imaging (DI) services provider in Victoria. The opportunity is to now replicate the same successful growth through an acquisition strategy from Victoria into NSW and Queensland.

As the market sees evidence of this opportunity, I will be able to look at other successful aggregators such as Greencross (GXL), G8 Education (GEM) and 1300 Smiles (ONT) as a relevant comparable in regards to what PE and PEG ratios the company should trade on.

The Government’s Medicare funding initiatives aimed at increasing the access to low cost MRI scans has provided two large benefits. Firstly, it has increased the volume of scans thanks to Capitol having seven Medicare licensed MRI machines. Secondly, it is increasing the opportunity for consolidation as many smaller operators without MRI machines are struggling to survive.

Founder and managing director John Conidi is looking to replicate the Victorian success in NSW and Queensland, with those markets believed to be more fragmented than Victoria.

The long-term structural tailwinds include an ageing population and increasing focus on earlier diagnosis and prevention of disease.

I don’t expect the Medicare co-payments proposal from the budget to pass the Senate in its current form. However, I do expect a co-payment of some degree from the July 1, 2015. Whatever short-term impact there is for Capitol, it will again be outweighed by the long-term benefit of increased consolidation opportunities.

The company has pre-announced strong FY14 results, however from the result I am looking to see more explanation of future growth opportunities to justify the high short-term PE.

The stock is approaching my initial $0.54 valuation, but I expect this will be revised upwards after the full-year result.

I reiterate my last Buy recommendation from July 2.