Rebound hopes for three small cash cows

Don’t be fooled into thinking we have returned to some level of normality now that the sharemarket is up at a five-year high.

While no one quite knows what “normal” stands for anymore in the post global financial crisis world, those who doubt the market remains highly disjointed need only look at the explosion in the number of companies you can buy for less than the cash held in their bank account.

The number of stocks trading at a discount to their cash backing has surged 144% since the end of the 2012 financial year to 105 – the most in at least 10 years.

What’s more, the average share price to value of tangible assets (such as property, plant and equipment) has also plunged 37.5% to the lowest level in more than a decade at 3.4 times.

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All stocks going for less than their cash backing come from the junior end of the market, but small cap bargain hunters should not get too excited as this market anomaly is not usually good news. If anything, a pick-up in such occurrences typically coincides with a period of market stress.

This is because companies that are valued at or below their cash backings are essentially priced to fail, in the vast majority of cases. Why else would the market not ascribe any value to the company’s assets or operations?

This is why junior explorers dominate the list of stocks trading under their cash holdings as the fall in commodity prices, rising costs and the lack of access to capital are likely to see a number of them go under.

However, the poor sentiment towards small caps does seem extreme in some cases, particularly since the Reserve Bank of Australia went on the front foot yesterday and joined central banks from other developed nations to stimulate economic growth through record low interest rate settings.

The rate cut and the RBA’s willingness to drop the cash rate further to support demand have improved the outlook for cyclical stocks, and there are three small caps that could rebound in the second half as they arguably do not deserve to be trading at or under their cash backing.

Macmahon Holdings (MAH)

You can’t blame investors for shunning the mining contractor. Fear that it will issue another profit downgrade due to project deferrals and the messy divestment of its underperforming construction business has weighed heavily on the stock.

Macmahon’s 72% crash over the past year to its lowest level in a decade gives it a market cap that is only 4% ahead of its $183.5 million cash holdings.

The stock typically trades at more than four times its cash, but I am not predicting a near-term re-rating of the stock based on this metric.

What I do suspect though is that the stock is close to finding its feet, as Macmahon shouldn’t be priced to fall over.

If anything, its mining division has a record order book worth $3.6 billion that is made up largely of recurring work, and the company has a healthy balance sheet, particularly following its $80.7 million equity raising.

The company is also modestly geared at 9.4%, and while it warned back in February that it would report a net loss of between $10 million and $20 million for the current financial year due to costs associated with the sale of its construction division to Leighton Group, analysts are predicting a sharp rebound in net profit to $54.6 million in 2013-14.

The stock closed at 15.5 cents on Tuesday and the average broker 12-month price target is 29 cents.

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Jetset Travelworld (JET)

The travel agency is not only trading at a similar level to its cash backing as Macmahon, it’s also in the midst of a restructure to cope with challenging industry conditions.

A drop in the price of airfares, intense online competition, and big cuts in government spending on air travel (government is a large client of Jetset) contributed to an 11% drop in its first half total transaction value (TTV, value of airline tickets, accommodation bookings, etc that is processed through Jetset) to $2.5 billion and a 5% dip in adjusted profit before tax to $18 million.

I can’t see these pressures abating significantly over the medium term, but unlike media, we know that the traditional travel agency model can work, thanks to Flight Centre.

To Jetset’s credit, it has achieved cost savings above what most analysts had expected, and this meant its margin between revenue and TTV expanded 0.3 of a percentage point to 5.4% for its retail division and 0.5 of a percentage point to 13.7% for its wholesale business.

I don’t see a positive re-rating of the stock happening anytime soon given that it will take two years for Jetset to complete its strategic review; but the fact that it has nearly $170 million cash, no net debt, a cache of well-known brands, an expected grossed-up yield of around 9%, and a modest forecast price-earnings multiple of 6.5 times for 2013-14 means it might be worth buying if the share price dipped towards 35 cents.

The illiquid stock closed at 40 cents on Tuesday. Jetset’s top three shareholders hold around 86% of the stock.

Richfield International (RIS)

The microcap shipping services company is a more extreme example as it holds three times as much cash as its $3.2 million market cap.

One would think debtless Richfield would make a tempting takeover target just for its bank balance alone, if not for its managing direction, Chak Chew Tan, controlling around 37% of the company. Tan and his wife are on the company board and the next three biggest shareholders have another 46% of the stock.

But liquidity is not my biggest concern – it’s transparency. Richfield declined an interview request and not much is known about its Singapore-based management team or its other key Asian investors.

While the company has a fairly clean balance sheet, it has $5.7 million worth of intangibles sitting on its books that is related to goodwill on acquisitions. The intangibles constitute 34% of Richfield’s total assets.

On the upside, Richfield managed to post a 68% increase in net profit to $272,000 in the financial year ended December 2012, even as the shipping industry was hammered by the slowdown in global trade and oversupply of vessels.

The turmoil caused Richfield’s revenue to fall 8% to $6 million, but good cost control enabled the company to bolster margins considerably.

That is quite impressive given that 65% of its listed global peers posted a loss for the latest reporting period.

Richfield is leveraged to any improvement in shipping demand and management is expecting “moderate growth in shipping” this year.

The 26% rebound in the Baltic Dry Index, which reflects the price to ship cargo internationally, seems to support management’s outlook.

Management better be right. If conditions deteriorate, there is a real risk that Richfield will have to write down a portion of that large intangible that is on its balance sheet.

Risk tolerant investors who are unconcerned about potential governance issues might find the stock an attractive addition to their small cap portfolio, but for the rest of us, Richfield should be kept on a watch list for the next six months to see if management has a plan to unlock shareholder value at the next annual general meeting.

The stock has doubled in the past 12 months and is trading around 5 cents, but this is still well below the company’s net tangible asset value of 12 cents a share.