Some healthy signs for medical care group

THE much-maligned medical centre and pathology group Primary Health Care has seen its shares fall 15 per cent since November last year. In the same period the Australian Health Care Index has been a star performer, notching up a gain of 15 per cent.

This 30 per cent underperformance can be sheeted back to a number of factors including low earnings growth, a lack of overseas exposure and a discount for management.

In recent weeks, though, sentiment towards the stock has started to turn. The share price has climbed 5 per cent, breaking a long downward trend. In recent years Primary has spent heavily on acquisitions and expanding its medical centre business. As a result, return on equity has plummeted to around 5 per cent, meaning the company does not earn its cost of capital. Not a great result for shareholders.

Now the company is reducing its capital expenditure program, returns could improve. Additionally, the medical centre business, the main driver of profits, seems to be enjoying better trading conditions.

If the company can produce cash, pay down debt and extract some earnings growth, its price to earnings ratio could expand two points from the current level of around 11 times. This would lift the share price to around $3.40.

Gold

I AM not a gold bug. Buying gold stocks is difficult because the underlying asset price does not depend on supply and demand. This does not mean you can't make money out of the precious metal, as evidenced by the 12-year bull run that has increased the price of bullion by about 500 per cent.

However, since August 2011 the bullion price has struggled, falling from a high of $US1900 an ounce to the current level of just over $US1600 an ounce. Interestingly, this has been an orderly decline and a highly unusual way to end a multi-year boom. Most bull-market tops are characterised by volatility and then a share decline. This alone suggests there may still be life in gold in a mature market.

On May 15 this year the price of bullion sunk to a low of $US1526 an ounce but has flicked up by about $US100 an ounce. Could this be the beginning of the next big leg-up in gold? This is difficult to work out at this stage, because if central banks around the world decide to get everyone a shot of extra liquidity then gold may just work its way higher, towards the inevitable end of a giant bull market.

What is even more intriguing is the fact that gold stocks peaked well ahead of the share price. In fact, gold company shares around the world are trading at their cheapest level, compared with the bullion price, in decades. Ideally, investors interested in gold should look back at gold stocks rather than bullion itself.

Furthermore, if the Australian dollar falls against the US dollar then the attractiveness of local gold stocks rise. However, the scenario of gold moving up and the Australian dollar moving down is rare and you should not hold your breath.

The Reject Shop (TRS)

IT IS hardly news that traditional shop-front retail businesses are struggling at the moment. The shy consumer and the onslaught of the internet has crippled top-line growth.

The discount variety chain, The Reject Shop, should be resilient in the face of these trends. The company concentrates on low-priced goods that are not easy targets for online retailers. However, these defensive qualities have not stopped the group's share price falling 28 per cent since mid-March compared with a 4 per cent fall in the benchmark All Ordinaries Index.

Analysts covering the stock have been winding back their earnings-per-share forecasts on the back of a deteriorating environment and a sagging Australian dollar. Adding to the company's woes is the stellar performance in recent times of Wesfarmers' Kmart, which competes with The Reject Shop in many areas.

The company is yet to comment, but at the current levels its shares are trading on a price-to-earnings ratio of 11 times 2013 financial year earnings. It is never wise to buy a company's shares if analysts are downgrading earnings, because no one is sure when that trend will end. However, The Reject Shop, with its defensive qualities, has a lot to offer prospective shareholders.

The company still has a major store rollout program to undertake over the next five years that should drive earnings. A retailer in this position can trade on a much higher PE ratio. The store rollout should be supportive as long as the management is able to buy quality stock and drive inventory turns.

It is worth watching this for the commentary at the next result and gauging if the outlook is healthy despite soft current earnings.