Trick to picking winners as market starts to surge
ASG Group
THE series of events at the West Australian-based IT services company should be a red flag for all investors. The group's share price has fallen 20 per cent since October, when it made the dual announcement of receiving an unsolicited cash takeover offer of $1.03 a share and a $15 million rights issue at 52¢. The rights issue was used to lower debt and was underwritten by UBS.
The group held its annual meeting in November and gave no indication of any operational or accounting issues. Then last week the company said it was writing off $14.9 million (co-incidentally almost the same value of the underwritten rights issue in October) of capitalised contract establishment costs.
It also announced it was undertaking a formal review of its accounting policies relating to cost deferrals, capitalisation and amortisation of major contract wins. The announcement was topped off by the resignation of chief financial officer Stuart Whipp, who was replaced by chief operating officer and former CFO Dean Langenbach.
All of this is disconcerting enough for shareholders, but if we look back at the past two years of accounts it becomes doubly so. ASG has booked a total of $30.3 million net profit after tax (NPAT) and $57.1 million of earnings before interest, tax, depreciation and amortisation (EBITDA). It has also told the market it will book another $13 million of EBITDA for the six months to December 2012.
The cash flow statements for 2011 and 2012 tell a completely different story, revealing a total loss of $15 million.
It is difficult to believe that once the group stops capitalising costs it will be worth anything close to its $116 million market capitalisation.
Pacific Brands
AS THE market grinds higher and higher, investors keep trawling the share tables looking for stocks and sectors that have not yet re-rated.
Clothing group Pacific Brands reported a slightly better than expected result earlier this week but gave a conservative outlook, saying sales to date for the second half have been marginally below the previous corresponding period.
The reality, however, is that investor thinking has changed in recent months.
With its balance sheet back in order and renewed confidence in the management team, PacBrands looks relatively attractive. The group is trading on a PE ratio for the year to June 30, 2013 of slightly more than nine times and a fully franked dividend yield of 6.6 per cent. With a modicum of growth in 2014, the equation looks even better with the PE dropping to eight times and the fully franked yield rising to 7 per cent. A target of 95¢ a share as we enter the 2014 financial year is not beyond the group's reach.
Macquarie Group
INVESTORS were disappointed with Macquarie earlier this month when it said it would achieve a 10 per cent jump in earnings for the year to March 2013. This was 2 per cent to 4 per cent below market expectations and leaves the company sitting on a lofty PE ratio of about 16.5 times 2013 earnings. This seems extraordinarily high given the bank achieves only a 7 per cent return on its equity.
Investors knocked 7 per cent off the share price. No doubt the result was an excuse for many shareholders to sell and move on following a near 70 per cent rise from July 2013 to February 2013.
A few days following the announcement, however, Macquarie's share price bottomed and since February 7 it has risen a healthy 7.3 per cent, recouping most of the losses triggered by the announcement.
Critically, Macquarie also said at its announcement in early February that it could do better than 10 per cent earnings growth in 2013 if markets continued to improve. Since then equity markets have continued to surge.
All of Macquarie's business benefits from a rising equity market. On this basis, it would be advisable to stick with the stock until at least the full-year result is released at the end of April.
matthewjkidman@gmail.com. Fairfax Media takes no responsibility for stock tips.
Frequently Asked Questions about this Article…
ASG Group’s share price fell about 20% since October after it announced an unsolicited $1.03 a share cash takeover offer and a $15 million rights issue at 52¢ (underwritten by UBS). More recently the company wrote off $14.9 million of capitalised contract establishment costs, launched a formal review of accounting policies on cost deferrals and amortisation, and saw its CFO resign (replaced internally). Those items, together with mixed cash flow results, are clear red flags for investors.
A rights issue can dilute existing shareholders but is often used to reduce debt—ASG said the $15 million rights issue was to lower debt and was underwritten by UBS. An unsolicited takeover offer can create uncertainty about strategy and value. In ASG’s case the dual announcements coincided with a roughly 20% fall in the share price, illustrating how such corporate actions can increase volatility and investor caution.
The write‑off of capitalised contract costs and the review of accounting policies may indicate prior earnings were boosted by capitalisation practices. The article notes ASG reported positive NPAT and EBITDA over two years but a total cash flow loss of $15 million. If the group stops capitalising those costs, its future earnings and therefore the market valuation (around $116 million at the time) could be materially lower.
Profit metrics such as NPAT and EBITDA can be affected by accounting choices like capitalising costs. For ASG the last two years showed $30.3 million NPAT and $57.1 million EBITDA, but the cash flow statements for 2011–2012 revealed a $15 million total cash loss. Comparing cash flow to profit helps reveal the underlying financial strength and whether reported earnings are supported by actual cash generation.
The article suggests Pacific Brands looks relatively attractive: it reported a slightly better‑than‑expected result, has a conservative near‑term outlook with sales marginally below the prior period, and its balance sheet is said to be back in order. The stock was trading at a price‑earnings ratio of a little over nine times for the year to June 30, 2013, with a fully franked dividend yield of 6.6%. With modest growth into 2014 the PE could fall to about eight times and yield rise to ~7%, and the article suggested a 95¢ per share target entering the 2014 financial year.
Macquarie guided to about a 10% earnings rise for the year to March 2013, which was 2–4% below market expectations and left it trading on a roughly 16.5x PE for 2013 earnings. Investors initially knocked about 7% off the share price, but the stock recovered and rose about 7.3% from its bottom since February 7. Macquarie also noted it could exceed 10% earnings growth if markets continue to improve, and because its businesses benefit from rising equity markets the article advises holding the stock at least until the full‑year result at the end of April.
According to the article, all of Macquarie’s businesses benefit from a rising equity market. Management said the bank could do better than the guided 10% earnings growth if markets continued to improve. Since equity markets have continued to surge, that strengthens the case that Macquarie’s earnings could outperform the initial guidance.
The article’s practical guidance for everyday investors is to be selective even in a bull market: watch for accounting or operational red flags (like large write‑offs or policy reviews), compare cash flow to reported profits, prefer companies with healthy balance sheets and confident management, and look at valuation metrics such as PE ratios and dividend yields. It also suggests staying with quality names through near‑term volatility until reporting clarity (for example, waiting for full‑year results).
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