A multi-year acquisition spree by Coffey International ran into trouble in 2010, triggering a major overhaul, with John Douglas appointed chief executive. The result is a classic turnaround play.
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 costs base and discontinue some lines of business.
This initially fell flat with investors with the share price falling from $1 to a low of 36? last October. 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.
Most people are nervous about buying stocks that are surging higher, believing they have missed the opportunity. 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 heartwarming. The company said it expected a full-year EBITDA of $45 million and flagged reduced interest and tax costs in the second half. Both of these reductions could be substantial given the lower debt levels and the 60 per cent tax rate.
It is possible the company could clock up a net profit for the current half of somewhere between $8 million 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 is a notoriously risky investment. The new management team seems to have made all the right moves but the environment must be accommodating otherwise the financial improvements made will never see the light of day.
BREVILLE HITS US
Staying on the topic of catalysts, a major positive has taken place for the kitchen appliance company Breville Group (BRG). Its share price has been on a tear recently, prompting its major shareholder and local competitor GUD Holdings to unload its 19.3 per cent stake. GUD bought its stake in May 2009 for just 72? and this week offloaded to investors at $3.35. When GUD bought the stake it was a catalyst for BRG to re-rate and ironically, the sale this week could prove another catalyst. Due to the ACCC blocking a merger of the two groups, GUD's stake went from a sign of a takeover to an overhang. Now the overhang is gone BRG's share price should be liberated.
BRG has achieved a feat that virtually no small companies have accomplished over the years - it has succeeded in the US. Investors should be searching for exposure to the US market as the world's biggest economy shows signs of recovering. In BRG's latest half-yearly accounts, North American EBIT spiked 82 per cent year on year, easily offsetting the softer Australian market. Interestingly, the game in the US has some years to play out yet. The company has only released a small range of products there and with its current footprint it now has the distribution power to spread its offerings.
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 rising dollar. Keep a close eye on these swing factors.
When trying to pick stocks it is always beneficial to avoid companies that might underperform. One of these could be cast steel manufacturer and supplier Bradken Limited. Bradken is in a sweet spot given it supplies and maintains products for the mining and infrastructure industries. Since October the stock price has risen 25 per cent.
A stock price rise though should not smooth over the numbers. It is critical that we keep an eye on the cash flow. Bradken is a capital intensive business. To grow its earnings at a rate to satisfy investors it needs to invest funds into the business. In 2012 capital expenditure will be $160 million. This large slug of capital will ensure there is no free cash flow for 12 months. 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, but in Bradken's case it happens regularly. This has the impact of forcing the company to raise capital, either equity or debt, diluting shareholder returns. This is not ideal for investors.
In a new weekly column, former fund manager Matthew Kidman looks for diamonds and dogs in the share market.