Earnings season: Expect the unexpected

This earnings season will reward eagle-eyed investors. Here’s what we’re watching.

The powerful stockmarket performance of the last two years has brought a new generation of investors to the stockmarket. At Eureka Report we believe ‘It’s Time’ for these investors to widen their investing lens beyond the banks and blue-chips to small and medium-sized companies where the real price action will take place in the months ahead.

As the market teeters on a long overdue correction (we’ve lost 5% this year so far) we’re watching both for bargains and for situations that might demand an exit.

Today I want to detail just how lively our local market has become and then hand pick a number of situations an active investor might need to be across during this month’s earnings season.

The kick-off for the reporting season is an especially anxious time for investors. Every reporting season throws up its fair share of surprises, but investors should brace for violent price swings given that the dismal trading start to the month is adding to tension.

The 2.8% losses suffered in January were extended into February, with the All Ordinaries Index shedding a further 2% due to global economic headwinds.

We have to see meaningful earnings growth this year if the market has any hope of marking another year of gains after the All Ordinaries delivered 20% total return in calendar 2013. The problem is that the jury is still out on the profit front, and the outlook statements from this month’s reporting season will play a big part in setting the tone of the market for the next six-months.

Volatility back from the grave

Investors are already walking a tightrope with the dramatic share price swings of electronics retailer JB Hi-Fi (JBH), budget retail chain The Reject Shop (TRS) and packaging company Colorpak (CKL) a sign of things to come for managers who surprise the market. If a company fails to meet expectations, it will be harshly dealt with. If it exceeds, it will likely enjoy a strong bounce.

If volatility is the barometer of tension, then the blood pressure of shareholders has risen markedly in recent times. Short-term share price gyrations on the S&P/ASX Small Ordinaries, as indicated by the 10-day average volatility, have more than doubled in magnitude in three weeks to 18%.

While the level of “fear” is nowhere close to what it was mid last year, when the 10-day gauge spiked to over 30%, it still stands in contrast to last February when the volatility reading was hovering under 10%.

The Reject Shop contributed to the volatility when it plunged over 30% on disappointing earnings, while JB Hi-Fi surged 4% this week on upbeat first half earnings. Both stocks are part of the small ordinaries.

Stocks in the hot seat

The question bugging investors is who could be next to spring a surprise? There is no shortage of candidates.

Among the companies on my “outperform” list, there is a risk that women’s apparel retailer Specialty Fashion Group (SFH) could disappoint as the retail environment is still throwing up very mixed signals.

The issue facing Specialty Fashion is the “curse of expectations”. The group managed to post a turnaround in net profit of $13 million in 2012-13, from a loss of $2.8 million the year before, as it emerged from a restructure.

Shareholders now want to see top-line growth, with the market pencilling in a 0.7% increase in sales to $313.3 million for the six months ended December 31. That doesn’t sound like much of a hurdle, but investors are expecting sales growth to accelerate in the second-half with full-year revenue tipped to expand 16.4% to $663 million.

Management’s outlook statement will be scrutinised closely for any early signs of disappointment. But investors can take some comfort from the strong result of rival Country Road (CTY), which managed to deliver a 27% upswing in interim revenue to $346.3 million from its Australian stores.

What is expected to bolster Specialty Fashion’s sales is its online push and the recent acquisition of Rivers Australia, although shareholders will have to wait until 2014-15 to feel the full earnings benefit from the deal. 

Watch this space, as Specialty Fashion could go either way when it releases its result on February 25. But if it does get sold off, it will be a buying opportunity for longer-term investors. I reiterate my “outperform” call on the stock, which is trading around 86 cents. Country Road is not part of the Uncapped 100.

Another on the “buy” list that is causing some amount of anxiety is engineering contractor NRW Holdings (NWH), especially since LogiCamms’ (LCM) depressing update yesterday. This drove LogiCamms to its worst one-day loss on record, when it plunged 22.5% to $1.10.

LogiCamms warned that earnings before interest, tax, depreciation and amortisation (EBITDA) would come in between $11 million and $13 million for 2013-14, compared with last year’s figure of $14.1 million.

The drop might appear relatively minor in a sector that is used to big profit downgrades – such as the recent experience with Forge Group (FGE) – but the LogiCamms news is still a blow to confidence, as management had been guiding for earnings growth this financial year and analysts were forecasting EBITDA of $16.4 million.

While the trading update is disappointing, I am sticking to my “outperform” call on the stock as the damage is largely done with the stock. It is trading on a 2013-14 price-earnings (P/E) ratio of around eight times, and a P/E of seven times for the following year if I factor in a relatively conservative 10% earnings growth.

What’s perhaps more encouraging is management’s implicit comments that things have picked up in recent months. Indeed, the company’s guidance indicates that three quarters of expected profit will be booked in the six months to the end of June this year.

Further, most of the earnings miss can be attributed to a softer-than-expected first-half, with the new downbeat company guidance suggesting that second-half earnings are tracking close to market expectations.

I also do not think its dividend is under threat, and LogiCamms has the financial muscle to hold distributions steady at 9 cents a share. That might disappoint some investors given that the consensus expectation is calling for a 9.5 cent payout; but even a flat dividend would put the stock on an attractive fully franked yield that’s close to 12%.

Coming back to NRW, no news is good news. One would have thought if the contractor needed to issue a profit warning, it would have done so already.

Just meeting expectations might just be enough to send the stock higher because, unlike LogiCamms, the market doesn’t have much confidence in NRW’s outlook. What’s more, the market is expecting NRW to post a 34.5% decline in sales to $530.7 million and a 45.9% slump in net profit to $26.3 million for the six months ended December.

Further, analysts believe shareholders will have to wait until 2015-16 to see modest earnings growth for the group, with the stock trading on an attractive P/E of under seven times for the next few years and a gross-up yield of over 10%.

I am reiterating my “outperform” rating on NRW, although those looking to buy might prefer to wait until after the release of its half-year result on February 27. LogiCamms will announce its results the day after.

An Uncapped 100 stock that could deliver a pleasant surprise that I’m adding to my “buy” list is NetComm Wireless (NTC).

I am expecting management to give an update on the many global deals it struck over the course of 2013 when the wireless device maker announces its half-year result in mid-February.

One of the more significant deals NetComm struck is with Vodafone. NetComm will supply machine-to-machine (M2M) to the telecom giant on a global basis. M2M is one of the fastest growing technology segments as things like smart meters and contactless cards are becoming ubiquitous in everyday life.

The company is also entering the United States M2M market through a partnership with SYNNEX Corporation and Verizon Wireless, and also has struck a supply agreement with United Arab Emirates’ telco Etisalat Group for its M2M equipment.

Updates on these deals and on wireless device sales to the National Broadband Network could well make NetComm’s full-year guidance look conservative, even though the 2013-14 figures are expected to be significantly ahead of the previous year’s.

The company is predicting that EBITDA will come in between $4.6 million and $5.1 million, and revenue to reach $58 million to $63 million. NetComm booked an EBITDA of $803,000 and sales of $42.9 million in 2012-13.

Colorpak loses hue

Meanwhile, Colorpak is the latest member of the Uncapped 100 to hand in its report card, and it left investors seeing red. The stock suffered its worst one-day sell-off on Tuesday since recording a similar crash back in 2008. You can read the details of its half-year results here.

Management is promising a turnaround in 2014-15 after posting a 44% decline in half-year net profit to $2.7 million due to higher-than-expected restructuring costs and weaker customer demand.

Thankfully, the unexpected drop in profit won’t impact on dividends. Colorpak is holding its fully franked interim dividend at 1.75 cents a share.

The stock is not expensive, as it is trading on a 2014-15 price-earnings multiple of around eight times and a yield of close to 7% once franking credits are included.

But a stock like Colorpak should be attractive for its relatively defensive business, and it is clear it has not reached that transition point. This duckling has yet to turn into a swan, and investors looking to buy Colorpak for its recovery need not rush.

This is why I am downgrading my recommendation to “neutral” from “outperform”. Colorpak was first highlighted as a buying opportunity on July 17 last year when it was trading at 73 cents, before peaking at 89 cents in December. The stock was trading around 80 cents today.

Think big, go smalls!

* This article is part of the “It's Time” series in Eureka Report focussing on new opportunities for investors in 2014. Click here to see the entire series.

Uncapped 100 stocks with an "outperform" recommendation

NameCodeDate of recPrice*Total rtn since (%)Article Name
eBetEBT26-Jun-13$1.13169.1Small cap with biggest earnings upgrade
Silex SystemsSLX3-Jul-13$2.32-11.42Why a dog can be an investor's best friend
NewsatNWT3-Jul-13$0.4018.35Why a dog can be an investor's best friend
Tiger ResourcesTGS3-Jul-13$0.1980.26Why a dog can be an investor's best friend
M2 Telecommunications GroupMTU10-Jul-13$6.022.27Big expectations for small caps
Starpharma HoldingsSPL17-Jul-13$0.94-17.55Five bargains for under a buck
GI DynamicsGID17-Jul-13$0.6028.33Five bargains for under a buck
Horizon OilHZN17-Jul-13$0.36-12.91Five bargains for under a buck
Collins FoodsCKF7-Aug-13$1.7617.43The next dividend dazzelers
LogiCammsLCM7-Aug-13$1.47-27.79The next dividend dazzelers
NRW HoldingsNWH14-Aug-13$1.1421.43A mining services revival?
WDSWDS14-Aug-13$0.5972.83A mining services revival?
ThinksmartTSM21-Aug-13$0.3631.39Biggest smalls earnings surprises
Beadell ResourcesBDR28-Aug-13$0.87-13.29Short-selling gold signals
Universal BiosensorsUBI4-Sep-13$0.68-30.15Smalls in sweet spot
Specialty Fashion GroupSFH18-Sep-13$0.93-7.53Small cap surprises for 2014
Mint WirelessMNW2-Oct-13$0.1880.56Four new stocks for Uncapped
YTC ResourcesYTC9-Oct-13$0.26-9.62Xmas sale starts early for small caps
Ridley CorporationRIC16-Oct-13$0.85-5.29Appetisers from the agri stocks field
Wide Bay AustraliaWBB16-Oct-13$5.603.04Appetisers from the agri stocks field
STW CommunicationsSGN30-Oct-13$1.58-10.48Small consumer stocks at Christmas crossroads
Retail Food GroupRFG30-Oct-13$4.58-8.52Small consumer stocks at Christmas crossroads
NanosonicNAN6-Nov-13$0.834.22First profit, first choice for stock pickers
AMA GroupAMA6-Nov-13$0.37-23.29AMA chief's double plan
eServGlobalESV13-Dec-13$0.7025.71Calculating Bitcoin's flow-on effects
CTI LogisticsCLX18-Dec-13$2.3502.98CTI's road to expansion
Altona MiningAOH4-Feb-14$0.172.94Special Report - A small miner you cannot miss
*Price on date of publication
Source: Eureka Report, Bloomberg

Uncapped 100 - Australia's most interesting small cap stocks

Small cap stocks covered by the Uncapped team
CodeNameRationaleMarket cap ($m)Total return 1-year (%)Sector (GICS)
NHF NIB HoldingsOnly listed health insurer. Widely held. Good performer.1,101.9015.2Financials
MTU M2 Group Amazing growth story and well run company. High free float and strong insto support.1,080.7945.36Telecommunication Services
GEM G8 Education Only listed childcare operator. Acquisition strategy paying off with stock delivering solid gains.951.88101.31Consumer Discretionary
MMS McMillan Shakespeare One of the best performers since the GFC, but ongoing risk of change to FBT rules will hang over the company.855.54-15.31Industrials
ARP ARB Corp Well covered but good candidate for core holding due to quality management.814.690.79Consumer Discretionary
AAD Ardent Leisure GroupWidely held stock. Earnings more defensive than anticipated. Good yield. Potential core holding.806.0635.55Consumer Discretionary
SRX Sirtex Medical A shining star in the biotech space and one of the best performing stocks in 2012. Great product (liver cancer treatment) and bright outlook.783.8319.5Health Care
GXL Greencross Acquisitive veterinary group that is embarking on new growth phase via merger with pet products retailer769.89126.11Health Care
BGA Bega Cheese Corporate interest in Australian food companies makes the cheese maker worth following.746.77120.91Consumer Staples
MRM Mermaid Marine Australia Its strategically located facility on WA coast gives it a key advantage over competition in servicing Gorgon & Pluto projects.665.39-25.23Industrials
AUB Austbrokers Holdings The insurance broker is a strong performer. Widely held and well liked by small cap investors.664.6833.32Financials
RFG Retail Food Group Owns a number of well know franchise brands. Widely followed by instos.604.2932.49Consumer Discretionary
BDR Beadell Resources Will be a very big FY14 for miner as it has to prove it aims to produce 200,000 ounces of gold a year.593.05-18.48Materials
SGN STW Communications Group One of few companies able to benefit from online shift. Widely held and good insto support.570.4115.75Consumer Discretionary
CWP Cedar Woods Properties Property developer with good ROE and earnings growth track record.551.1550.58Financials
BRU Buru Energy Substantial size but not often covered by press. Widely held with good insto support.544.77-23.96Energy
TGR Tassal Group Salmon farmer is finally turning a corner with an improved harvest strategy and growing demand for product.498.86124.1Consumer Staples
AMM Amcom Telecommunications Well covered junior telco but good candidate for core holding.480.5533.09Telecommunication Services
SEA Sundance Energy Australia Analysts have a favourable take on the oil & gas explorer, but stock is still under radar of most. Sundance provides exposure to prospective Eagle Ford shale.456.235.91Energy
CCP Credit Corp Group Strong price run attracted good investor interest. Leveraged to any rise in loan defaults. Not well covered by press.439.1810.18Industrials
TOX Tox Free Solutions Widely held stock in the waste solutions business. Its unique because it operates in a defensive-growth niche.437.704.29Industrials
NXT NEXTDC The cloud computing company is an IT sector darling. Fairly widely held and followed.420.4727.38Telecommunication Services
RCR RCR Tomlinson Good first half FY13 result and outlook, but will its fortunes change this year with the mining capex slowdown?417.6134.73Industrials
IPP iProperty Group Worth watching as it is trying to be the REA Group of Asia.415.40134.87Information Technology
MYX Mayne Pharma Group Sizeable generic drug maker with interesting board members.412.7392.76Health Care
MYS MyState Well regarded and could make good alternative to bank stocks. Has good yield and earnings growth over past few years.410.0025.14Financials
HZN Horizon Oil One of better regarded small energy stocks that doesn't receive much media attention.396.85-28.92Energy
CCV Cash Converters International Strong performance is attracting investors. It's Australia's only listed pawn shop and pay day lender.370.88-21.91Consumer Discretionary
NWH NRW Holdings One of the better regarded mining & civil contractors with good track record in delivering on projects.366.74-23.32Industrials
MOC Mortgage Choice Has a good track record and is leveraged to any housing recovery. The stock is also liquid with good insto support.363.9164.01Financials
SLX Silex Systems Its uranium enrichment technology could become one of Australia's best innovations given its potential to change the nuclear power industry.350.96-33.55Information Technology
SHV Select Harvests Noteworthy for turbulent past and exposure to soft commodity market.339.38247.34Consumer Staples
UXC UXC Company has turned corner and enjoyed re-rating. What's next?336.581.3Information Technology
ACR Acrux One of the more successful Australian biotechs in recent history but has run into some headwinds. Widely held by instos.320.55-43.99Health Care
TFC TFS Corp The sandalwood products company offers exposure to both the agri and cosmetics industry. It will start commercial harvest this year.319.54113.93Materials
AEU Australian Education TrustWell performing childcare centre property owner. Good yield story and outlook. 311.7122.21Financials
GID GI Dynamics IncLargely forgotten by investors after poor IPO but could attract attention this year as it looks to gain US approval to use its intestinal liner on diabetics.300.282.67Health Care
TGA Thorn Group One of few retail stocks that is performing well despite its flat outlook for FY14. The Radio Rentals chain owner is also well supported by instos.298.996.84Consumer Discretionary
BNO Bionomics One of the larger cancer treatment developers in this market.298.2377.58Health Care
IMF Bentham IMF Litigation funder is unique stock. Stock not liquid but its outlook appears promising given the number of potential class action lawsuits.281.911.88Financials
NWT Newsat Potential large cap if it can launch its own satellite in 2015.276.51N/ATelecommunication Services
RKN Reckon Fierce competition for cloud base accounting software puts it in firing line.275.42-8.91Information Technology
TGS Tiger Resources Future lies in its Kipoi copper mine expansion in the Congo but miner is fully funded with DRC govt holding 40% stake in tenement. Next 12mths will be interesting.274.932.24Materials
AJA Astro Japan Property GroupStrong leverage to Japanese economy makes this an interesting stock to watch.256.0815.45Financials
VOC Vocus Communications Telecom stocks are in favour for their dividends but Vocus is one of the least covered255.2676.38Telecommunication Services
RIC Ridley Corp High corporate interest in the sector and the shrinking pool of agri listed stocks make Ridley worth following.247.79-25.05Consumer Staples
CLH Collection House In similar space as Credit Corp. Strong stock performance has attracted a following and the stock appears to be well placed to run further233.4335.87Industrials
NAN Nanosonics A successful medical tech story. Should be close to turning in maiden profit with its disinfection device.227.6071.29Health Care
SPL Starpharma Holdings Noteworthy for its good pipeline of innovations. Well run, widely followed.223.45-33.19Health Care
ESV Eservglobal Mobile money transfer company that has been gaining traction. Widely held by instos but low press coverage223.12112.05Information Technology
MXI MaxiTRANS Industries Transport equipment maker posted good interim result. Has appealing yield and growth.220.7924.9Industrials
WBB Wide Bay Australia The building society is trying to turn its fortunes around. Also worth watching for its exposure to Queensland housing market, particularly around major resource projects.209.10-12.73Financials
RCG RCG Corp The footwear retailer is one of the best performing consumer stocks as online competition is not a big threat. Company has a good yield as well.205.9167.97Consumer Discretionary
HSN Hansen Technologies Operates in a high potential/growth industry but is not covered by press or brokers.195.9042.66Information Technology
IFM Infomedia Interesting tech play in the car parts market. Strong share price gain but gets little air play.193.6581.68Information Technology
PFL Patties Foods Illiquid stock but has suite of well recognised consumer brands. Defensive yield.193.41-12.3Consumer Staples
NEA Nearmap A stellar performer with an Interesting business that offers high quality aerial maps to companies & government.190.29726.09Information Technology
ACL AlchemiaOne of the few biotechs with revenue stream. Good pipeline of oncology treatments.186.5491.67Health Care
CKF Collins Foods One of the few food franchise listed companies.185.7738.42Consumer Discretionary
SAR Saracen Mineral Holdings Emerging gold producer that is widely held by instos. Hitting milestones and looks cheap. Key asset is close to gold majors, which makes it a potential takeover target.184.53-20.51Materials
DWS DWS Will be a big beneficiary if governments start spending on IT again.169.42-15.16Information Technology
SFH Specialty Fashion Group In early stages of turnaround. Can the women's apparel retailer sustain the momentum?165.321.71Consumer Discretionary
CLX CTI Logistics Logistics solution company with good track record of growth and exposure to online retail and large gas projects on West coast.157.3152Industrials
GHC Generation Healthcare REITOne of the more interesting REITs. Income is more defensive than typical property stock and its greenfield expansion gives it earnings growth potential.142.8133.83Financials
SIV Silver Chef Strong jump in the share price of the equipment financing group has attracted a good following.141.83-11.48Industrials
DTL Data#3 Well respected IT company that receives little press coverage.134.73-30.92Information Technology
MNW Mint Wireless Huge market potential if the mobile card payment solutions provider can gain market traction. Management aiming for $1 billion in transaction value a year.131.261610.53Information Technology
WDS WDS Widely held with strong insto support. Engineering contractor diversified across mining, energy and infrastructure.129.5474.28Industrials
IMD Imdex Drilling company is well supported by instos and should benefit from any rebound in exploration activity.126.28-64.96Materials
BGL BigAir Group The wireless small cap has gained strong following over past year or two but is often overlooked by investors and the press.125.8728.4Telecommunication Services
POH Phosphagenics Sizable biotech with a game changing FY14 year ahead. Good insto following but questions of poor audit and governance standard could dog company.122.46-20Health Care
MCP McPherson's The personal care and household products supplier had been relatively insulated from volatile discretionary spend and online threat, but growing earnings is still a challenge.121.25-38Consumer Discretionary
DRM Doray Minerals Widely held by instos. One of the more favoured gold explorers by brokers.119.1914.29Materials
MLB Melbourne IT A perennial underperformer could be interesting turnaround story as it undergoes a restructure.115.8714.42Information Technology
AZZ Antares Energy Liquid with good insto support. Already in production with exploration upside in Texas.104.55-22.64Energy
REX Regional Express Holdings Well run airline that is overshadowed by Virgin and Qantas.96.39-24.57Industrials
RUL RungePincockMinarco IT company to resource industry. Facing tough operating climate with new CEO trying to restructure and turnaround company.95.416.8Industrials
AMA AMA Group Good turnaround story but under the automotive services group is radar of most.93.59-22.95Consumer Discretionary
AOH Altona Mining Noteworthy copper play with Xstrata pull-out of Roseby project in Australia and the good ramp up of its Finnish project.93.14-18.6Materials
EML Emerchants Trying to change way corporates and governments disburse cash with its trackable and controllable debit card offering. If company can get $1 billion in loaded value on cards, the stock will surge.91.01305.56Financials
CLV Clover Corp One of the star performers in 2012. Operates in growing but relatively stable niche.87.555.86Health Care
UBI Universal Biosensors IncWell regarded biotech and one of few that's successfully manufacturing in Australia. Struck deal with a few global medical companies.83.29-44.77Health Care
BOL Boom Logistics Crane hire group is riding out the downturn in construction.  It's widely held by instos and is very liquid.80.73-39.29Industrials
CAA Capral An aluminium manufacturer that is actually holding up relatively well given that manufacturing is on the nose. 80.45-24.44Materials
LGD Legend Corp Electronic parts supplier to utilities and other industries. Stable earnings with good yield. Often overlooked.80.1234.81Information Technology
JIN Jumbo Interactive Innovative small cap facing off industry dominated by giants. Worth watching to see if it can carve out a profitable global business.79.46-35.2Consumer Discretionary
YTC YTC Resources Next 12-mths will be eventful after YTC secured funding for its projects from Glencore.77.00-14.55Materials
LCM LogiCamms Strong price performance and reasonable valuation attracting interest.74.03-20.14Industrials
PEN Peninsula Energy Widely held by instos and large free float. It's the only uranium miner on the list.71.56-42.11Energy
TAN  Tandou The only direct equity exposure to cotton prices. Also trades water rights and receives little press.70.158.79Consumer Staples
GXY Galaxy Resources Good upside potential if it can get its problem-prone Jiangsu plant back on track. Won't be easy to right this ship.68.81-74.18Materials
TSM ThinkSmart Potential turnaround story worth keeping eye on.67.3687.92Financials
CKL Colorpak The small cap packaging company has grown via acquisitions over past few years.61.9724.43Materials
FGE Forge Group Good track record has been marred by a recent shock downgrade and capital raising. How long will it take to redeem itself?60.32-87.18Industrials
KOV Korvest The construction products and services supplier has been hit by project delays and deferrals. But its relatively high yield could give it some support.59.94-1.76Industrials
CUV Clinuvel Pharmaceuticals Interesting skin disorder treatment developer that has done reasonably well over past year53.50-42.86Health Care
EBT eBet Potential alternative to star performer Ainsworth Tech. Has exclusive deal with US poker machine maker WMS.45.97123.05Consumer Discretionary
NTC NetComm Wireless Under appreciated small IT hardware maker that is punching above its weight. Hardly covered by press.44.4443.75Information Technology
OTH Onthehouse Holdings Alternative small cap to online property leader REA Group. It is trying to use more timely housing data as a competitive edge against REA.41.09-35.06Consumer Discretionary
PGC Paragon Care Emerging hospital equipment supplier that has been ignored by market.22.73-10.07Health Care
Source: Eureka Report, Bloomberg

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