The discounted dozen

PORTFOLIO POINT: Deep-value stocks can offer some of the best ways to profit from a market that is trending sideways or down, but often companies are sold-off for very good reasons. We go treasure-hunting among the ASX’s cheapest stocks.

There’s a saying, I’m told, popular in some of the seedier neighbourhoods of naval ports, that cheap tattoos aren’t good and good tattoos aren’t cheap. Among other things, I’m sure, this truism can certainly be applied to many stocks.

But where tattoos and stocks differ, is that at the smaller end of the market, certainly, there are companies that are genuinely undervalued due to a variety of linked factors: a lack of broker research, a size or liquidity too small for institutional investors, or a Beta too far removed from the benchmark.

Yet beyond these small-cap stocks, when a company does tend to fall to a big discount, there’s usually a very good reason, as Roger Montgomery explained on Wednesday, when he wrote about Cash Converters Limited.

This is unfortunate because in a sideways or down-trending market, like the one we’re experiencing, deep-value stocks can be of the best opportunities you’ll have to make money. It’s just that finding true value in this environment requires a bit more thought than a simple quantitative exercise.

By way of example, I crunched the ASX for stocks above a $50 million market cap that exhibited the most value based on their forward price/earnings multiple (P/E), their discount to consensus target and their price to net tangible assets. Based on these metrics alone, these stocks may look like diamonds in the rough, but readers who follow the stockmarket will notice a number of real dogs in there, too.

Put simply: there’s usually a good reason why a stock is cheap.

-Cheapest by the dozen: Price to earnings
Name	ASX	Market cap (m)	Price	Consensus target	Discount to target	Change 1 year	Price / NTA	Forecast P/E
Senex Energy Limited	SXY	$272	$0.36	$0.70	-48.57%	50.00%	2.22	0.9
Hastie Group Limited	HST	$75	$0.14	$0.23	-39.13%	-88.53%	-0.34	3.18
Gujarat Nre Coking Coal Limited	GNM	$426	$0.43	$0.80	-46.25%	-33.85%	0.75	3.21
Astro Japan Property Group	AJA	$165	$2.83	$3.83	-26.11%	-12.92%	4.94	3.53
Dragon Mining Limited	DRA	$91	$1.21	$2.18	-44.50%	31.52%	1.26	4.16
Photon Group Limited	PGA	$62	$0.04	$0.07	-42.86%	-96.08%	-0.34	4.44
Grange Resources Limited	GRR	$605	$0.53	$0.99	-46.97%	5.00%	1.07	4.53
Troy Resources NL	TRY	$306	$3.48	$4.66	-25.32%	42.04%	2.82	5.13
MEO Australia Limited	MEO	$97	$0.18	$0.28	-35.71%	-28.00%	0.46	5.45
Regional Express Holdings Limited	REX	$101	$0.83	$1.25	-33.60%	-17.41%	0.7	5.46
Centro Retail Group	CER	$766	$0.34	N/A		109.38%	0.81	5.49
Northern Star Resources Ltd	NST	$140	$0.46	$0.71	-35.21%	751.85%	9.57	5.97
					Source: Stock Doctor, Datastream

-Cheapest by the dozen: Price to NTA
Name	ASX	Market cap (m)	Price	Consensus target	Discount to target	Change 1 year	Price / NTA	Forecast P/E
Gunns Limited	GNS	$229	$0.27	$0.51	-47.06%	-55.74%	0.16	15
PaperlinX Limited	PPX	$97	$0.16	$0.23	-30.43%	-74.19%	0.18	-4.57
Geodynamics Limited	GDY	$69	$0.21	$1.08	-81.02%	-37.88%	0.24	-2.7
Elders Limited	ELD	$166	$0.37	$0.50	-26.00%	-5.13%	0.29	20.56
Aust Pharmaceutical Industries	API	$137	$0.28	$0.33	-15.15%	-28.21%	0.39	7
Sunland Group Limited	SDG	$138	$0.62	$0.82	-25.00%	-9.56%	0.42	7.41
AVJennings Limited	AVJ	$129	$0.47	$0.74	-36.49%	4.44%	0.43	0
ING Real Estate Comm Living Group	ILF	$51	$0.12	$0.14	-17.86%	130.00%	0.45	8.21
MEO Australia Limited	MEO	$97	$0.18	$0.28	-35.71%	-28.00%	0.46	5.45
Devine Limited	DVN	$159	$0.25	$0.32	-21.88%	6.38%	0.47	7.81
BlueScope Steel Limited	BSL	$2,220	$1.21	$2.15	-43.95%	-42.62%	0.48	-24.59
Boom Logistics Limited	BOL	$138	$0.30	$0.49	-38.78%	-22.08%	0.56	30
					Source: Stock Doctor, Datastream

-Cheapest by the dozen: Price to consensus broker target
Name	ASX	Market cap (m)	Price	Consensus target	Discount to target	Change 1 year	Price / NTA	Forecast P/E
Clean Seas Tuna Limited	CSS	$53	$0.11	$0.77	-85.71%	27.91%	0.53	-6.47
Nido Petroleum Limited	NDO	$67	$0.05	$0.28	-82.86%	-68.00%	1.25	N/A
Geodynamics Limited	GDY	$69	$0.21	$1.08	-81.02%	-37.88%	0.24	-2.7
WildHorse Energy Limited	WHE	$71	$0.29	$1.25	-77.20%	35.71%	1.49	-7.12
African Iron Limited	AKI	$86	$0.24	$0.99	-75.76%	152.63%	1.93	-240
Berkeley Resources Limited	BKY	$72	$0.42	$1.66	-75.00%	-63.27%	3.27	-5.93
Nyota Minerals Limited	NYO	$74	$0.16	$0.53	-70.75%	-47.46%	1.39	-38.75
Jupiter Energy Limited	JPR	$83	$0.05	$0.16	-70.00%	40.66%	2.19	-9.6
Silex Systems Limited	SLX	$497	$2.92	$8.69	-66.40%	-36.52%	3.66	-32.09
Centaurus Metals Limited	CTM	$69	$0.08	$0.24	-66.25%	12.50%	1.81	-27
Rialto Energy Limited	RIA	$158	$0.44	$1.20	-63.33%	22.22%	1.48	-23.16
Deep Yellow Limited	DYL	$169	$0.15	$0.37	-59.46%	15.39%	1.17	N/A
					Source: Stock Doctor, Datastream

Even if you queried the market as a whole for a combination of those three factors you would not have a perfect list. Looking at the companies above $50 million with a P/E under 7 times, a price to NTA ratio less than 1 (ie, parity) and a discount to consensus target of at least 20%, I get 12 stocks, but evidenced by their recent performance and the industries they are in – property in particular looms large – they are not all businesses I'd want to invest in.

-Cheapest by the dozen: P/E, NTA and broker target
Name	ASX	Market cap (m)	Price	Consensus target	Discount to target	Change 1 year	Price / NTA	Forecast P/E
Aspen Group	APZ	$255	$0.44	$0.60	-26.67%	-2.22%	0.68	7.21
Collection House Limited	CLH	$63	$0.65	$0.87	-25.29%	-13.33%	0.89	6.99
Devine Limited	DVN	$159	$0.25	$0.32	-21.88%	6.38%	0.47	7.81
FKP Property Group	FKP	$829	$0.70	$0.99	-29.29%	2.94%	0.54	6.73
Gujarat Nre Coking Coal Limited	GNM	$426	$0.43	$0.80	-46.25%	-33.85%	0.75	3.21
Grange Resources Limited	GRR	$605	$0.53	$0.99	-46.97%	5.00%	1.07	4.53
K&S Corporation Limited	KSC	$122	$1.41	$2.25	-37.33%	-43.80%	0.88	7.5
MEO Australia Limited	MEO	$97	$0.18	$0.28	-35.71%	-28.00%	0.46	5.45
PMP Limited	PMP	$205	$0.62	$0.99	-37.37%	8.77%	0.82	6.26
Regional Express Holdings Limited	REX	$101	$0.83	$1.25	-33.60%	-17.41%	0.7	5.46
Sunland Group Limited	SDG	$138	$0.62	$0.82	-25.00%	-9.56%	0.42	7.41
Select Harvests Limited	SHV	$103	$1.84	$3.31	-44.41%	-44.28%	0.81	6.74
					Source: Stock Doctor, Datastream

But if I overlay an assessment of each company’s growth prospects and the macroeconomic factors that may affect their industry, from the above, I can come up with a short list of companies – mostly small – that I do find interesting, despite that list now entering the realms of subjectivity. And while this list is fundamentally value-driven, it is nevertheless predicated on a view for growth. After all, per my belief, discussed several weeks ago and by Alan Kohler in February, that, small caps are to buy and hold (for growth), while blue-chips are to trade (for value). Where they do exhibit signs of value, it’s not because they’ve necessarily been shunned, it’s because they’re either small or illiquid, relatively unknown or still have their potential well ahead of them.

-The discounted dozen
Name	ASX	Market cap (m)	Price	Consensus target	Discount to target	Change 1 year	Price / NTA	Forecast P/E
Collection House Limited	CLH	$63	$0.65	$0.87	-25.29%	-13.33%	0.89	6.99
Clean Seas Tuna Limited	CSS	$53	$0.11	$0.77	-85.71%	27.91%	0.53	-6.47
Elders Limited	ELD	$166	$0.37	$0.50	-26.00%	-5.13%	0.29	20.56
Geodynamics Limited	GDY	$69	$0.21	$1.08	-81.02%	-37.88%	0.24	-2.7
Jupiter Energy Limited	JPR	$83	$0.05	$0.16	-70.00%	40.66%	2.19	-9.6
Nido Petroleum Limited	NDO	$67	$0.05	$0.28	-82.86%	-68.00%	1.25	N/A
PMP Limited	PMP	$205	$0.62	$0.99	-37.37%	8.77%	0.82	6.26
Regional Express Holdings Limited	REX	$101	$0.83	$1.25	-33.60%	-17.41%	0.7	5.46
Rialto Energy Limited	RIA	$158	$0.44	$1.20	-63.33%	22.22%	1.48	-23.16
Select Harvests Limited	SHV	$103	$1.84	$3.31	-44.41%	-44.28%	0.81	6.74
Silex Systems Limited	SLX	$497	$2.92	$8.69	-66.40%	-36.52%	3.66	-32.09
Senex Energy Limited	SXY	$272	$0.36	$0.70	-48.57%	50.00%	2.22	0.9
					Source: Stock Doctor, Datastream

Due the inherent restrictions of this quantitative method, a couple of my favourite companies – HGL Limited and Silver Chef Limited being two examples – are omitted, despite both being unfairly oversold in the current market. Nonetheless, of the above 12, there may be a few ideas for the risk-tolerant, patient investor.

Just remember that a lot of these stocks are volatile, as can be appreciated from their share price history. Investors may need to be prepared to lock their share certificates in the bottom drawer and walk away, if that’s what it takes, because although each has intriguing upside potential, I expect the next year to be tough for the market, and even the best growth or value story is not necessarily immune.

Collection House Limited

Small-cap debt collection agency Collection House (CLH) may operate in an unattractive niche, but if the economy turns it's the type of business that will do well either way. CLH has the added attraction of a high dividend yield, estimated on current prices to be 9.52% in 2010-11 and 2011-12, based on broker estimates. Despite its fall in share price over the past year, CLH has indeed been an excellent income stock, despite a relatively low payout ratio as a percentage of earnings per share.

Clean Seas Tuna Limited

Clean Seas Tuna (CSS) was profiled here early last month and despite its relatively lacklustre share price performance in recent months, it has exceptional potential to be one of the world’s most sustainable tuna fisheries businesses now that it has seemingly cracked the code to get tuna to spawn and grow in controlled conditions. With a massive international market and severe supply-side constraints elsewhere, even though CSS is yet to turn its innovation into a profit, in time it could be a great Australian success story.

Elders Limited

Elders (ELD), meanwhile, may be the agricultural industry’s opposite of a success story, but reshaped and refocused from its previous incarnation as troubled conglomerate Futuris, Elders is well positioned to ride the future boom in soft commodities (see Food for thought). ELD is also set to return to a much stronger profit, analysts believe, in the financial year ending September 2011, and while a dividend is probably still some time off, the market is yet to appreciate its potential for strong cash flows having been burnt in the past. What’s more, ELD sits on $2 billion worth of assets, as at March 31, which even against total liabilities of almost $1 billion is a massive plus for a stock with a market cap of $165 million.

Geodynamics Limited

Hot rocks, or geothermal energy, has been one of the most talked-about but worst-performing clean energy stories on the Australian market. Geodynamics (GDY), at the centre of this often-maligned sector, has borne the brunt, with a woeful record on the sharemarket. Nonetheless, with the government nearing an agreement on a carbon tax and a recent lift in GDY’s share price on the possibility it could generate a lot of cash through the sale or lease of its drilling rigs, indications are forming of better things to come.

GDY is otherwise forecast to remain unprofitable for the foreseeable future, but the reported net value of its assets are worth more than the company itself. This week GDY also reported on the progress of its Innamincka Deeps joint venture in the Cooper Basin with Origin Energy. The company said a clear program of major activity has been proposed for the coming year and the project's pilot plant is scheduled to be commissioned in 2012.

Jupiter Energy Limited

Jupiter Energy (JPR) is a more traditional energy play, albeit in many ways just as speculative, considering lack of revenue and profitability. Nonetheless, the Kazakhstan-focussed oil explorer trades at a massive discount to broker target and net tangible assets and is now also trading at a slight discount to a recent $11.1 million capital raising. Capital will be used fund its Block 31 work program, including the drilling of three wells. Results from its J-52, Lower Jurassic, well are expected soon and non-executive director Alastair Beardsall, who formerly ran FTSE-250 explorer Emerald Energy (now owned by Sinochem), recently purchased 10,000,000 shares.

Nido Petroleum Limited

Nido (NDO) is another speculative oil play, albeit with positive cash flow. Since written-up by me last year, the company has been a complete duster and undoubtedly my worst call. But taking a long-term perspective, there’s still hope yet and the disappointing results at its Tindalo and Gindara projects should be taken into context of the much greater geophysical potential of its permits offshore Philippines. NDO is not for the faint of heart, and its share price has been shamelessly exploited by day traders and rumour-mongers on internet chat forums, but as a tangible, real company it sits in one of the most prospective oil zones in Asia. It’s certainly high-risk, but it could be worth a punt at current levels.

PMP Limited

PMP, formerly Pacific Magazines & Printing, occupies a strange place in this list as a declining company in a declining industry, but unlike many of its peers, it is taking positive steps to diversify into value-added services, such as consumer analytics and creative advertising, plus it certainly looks cheap on a forward P/E basis. While yields are still relatively low, the company returned to a dividend in the last year and earnings per share are forecast to increase markedly from financial year 2010. Return on equity is decent at 11%, adjusted for significant items, for the December half on an annualised basis. PMP could be a good contrarian stock if you believe the market is being too pessimistic on the Australian economy and the Australian consumer. Either way, it could prove to be a cheaper exposure to the industrials sector should you wish to hold it.

Regional Express Holdings

Regional Express (REX), was discussed a couple of weeks ago as an alternative exposure to poorly-performing airline stocks Qantas and Virgin Blue (see Now boarding). While I still don’t advocate owning airline shares when faced with better alternatives, if you must then REX holds sound fundamentals in a good dividend yield, strong return on equity and a decent discount to target. Given my long-term views on the oil price (see Bittersweet crude), I’m not overly bullish on REX, a domestic regional-based carrier, but it could outperform should the Australian dollar turn, which I also believe will happen in the long term.

Rialto Energy

On the topic of oil, Rialto Energy (RIA) is yet another speculative energy play in our quantitatively derived list. Thanks in part to its exposure to civil war-ravaged Côte d’Ivoire, the company's share price has been in decline in recent months, but with normality restored in the West African country, and with other projects in far-safer Western Australia, its portfolio could look far more attractive in the future. RIA announced remaining minority interest in offshore Ivorian Block CI-202 last month, which contains highly prospective oil and gas discoveries. A two-to-three well drilling program is scheduled for early in the first quarter of 2012.

Select Harvests

Generally my approach to investment is top-down, rather than bottom-up, but happily Select Harvests (SHV), which operates in a sector on which I am fundamentally bullish, appears on this list. Like many here, SHV has done poorly in the market, yet a $3.31 consensus broker target remains on this $1.84 stock despite a strong Australian dollar and the announcement in May that Singaporean agri-giant Olam International does not intend to extend its management agreement for the former managed investment scheme operator. The almond harvester (which also packs and sells a range of other nut and dried fruit products) nevertheless has expanded its orchards significantly since Olam came to the rescue following the collapse of Timbercorp. Having recently negotiated a $115 million debt facility from NAB and completed the $19.5 million acquisition of Belvedere Orchards, SHV is focused firmly on the future, not its troubled past. It’s not without risk, but an investment in SHV wouldn’t be completely nuts either.

Silex Systems

Silex (SLX) was mentioned in previous article, The diminutive dozen. A solar and nuclear research and manufacturing business, like Geodynamics, its upside is predicated on government green energy policy, but with that looking virtually inevitable – despite the protestation of certain mining executives, backbenchers and non-members of the British House of Lords – it is showing signs of a rebound from one its lowest points in recent years. SLX recently announced the novation of $75 million in government funding for the development of its proposed 100 megawatt solar power station project in Mildura. The Commonwealth funding, which is in addition to an earlier grant from the Victorian government, is subject to a pilot demonstration plant, but nevertheless represents a key step forward.

Senex Energy

That’s not a typo. Senex Energy (SXY – no relation to Silex Systems) is an another energy hopeful, but operates in the very different areas of oil and gas exploration and coal seam gas. The company has recently been speculated to be under the gaze of Beach Energy (BPT), which, like SXY, operates in the Cooper Basin. The company's share price has been a solid performer in recent years and although it is still a small-cap stock, it has come to the attention of a number of traders. Research on the company is limited, but with a broker price target virtually double current levels, SXY has indications of strong potential.