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Thursday 17

January, 201912:12 AM



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Searching for Value in Low P/E Stocks

Searching for Value in Low P/E Stocks

By Bob Kohut 11.11.2013


One of the most time-honored investing strategies is finding stocks priced below their true value.  The Price/Earnings Ratio serves as the starting point for search but the P/E alone is never enough to separate a value stock from a value trap.  Some excited investors jump at the chance to buy a stock with a P/E multiple under 10 without considering what might need to happen to drive the price up.  Investors want to see growth over time and - in the absence of growth or any reason to believe growth is forthcoming - that low P/E stock may get a lot lower!

In short, some bargains are hard to resist while others are not always worth what you're paying.  Determining which is which is not easy but there are some indicators that can help.  To illustrate, we took the ASX 300 Market Summary Share Table for the trading day 6 November and found over thirty stocks with P/E ratios under 10.  From the thirty we first isolated the companies that provide goods and services to the mining and resources sectors.  Here is the list:

Stock (code)

P/E (06/11)Sector (P/E of 07/11) 
 P/B (MRQ)
 P/S (TTM)
Share Price 
52 Wk % Change

5 Yr  Total   Rtn

2 Yr Earnings Growth Forecast
5 Yr Est. P/EG

Ausdrill   Ltd

(ASL)
4.6Indus-trials (10.78)    0.52 
0.38 $1.38-51%
+8.9%
-10.1%1.44

Ausenco

(AAX)
8.1
Indus-trials (10.78)    0.340.72$1.55 -50% 
-4.3%-34.6% 
-2.19

Austin Enginee- ring

(ANG)   

9.9
Indus-trials (10.78)
1.0 
1.88
$3.77-10%
+25.6%
+3.8% 
-12.8%

Decmil Group (DCG)   

4.96 Indus-trials (10.78)
1.42 
0.73$2.25
-5%+69.9% +17.8%
2.9

Imdex Ltd

(IMD) 
7.8
Materials

(11.58) 

0.78
0.63$0.71
-48%
19% 
-26.8%-1.03

Leighton Holdings

(LEI)
8.5 Indus-trials (10.78)  
1.89  
0.30$17.07+1%
-2.6%  
+14.8%2.13

Numbers generally provide more meaning when used in comparison.  First we can compare each stock’s P/E against the P/E for the overall Industrials Sector, the XNJ and the Materials Sector, the XMJ.  Industrials lag the overall ASX which currently shows a P/E of 16.07 so one would expect lower P/E ratios across the Industrial Sector.  However, large variances such as you see with Ausdrill Ltd (ASL) and Decmil Group (DCG) could be a sign there's more trouble with those stocks than can be explained by a troubled sector.  A year over year share price chart reinforces the concern:

Having raised the concern we now need to acknowledge that comparisons often suffer from the “apples to oranges” problem due to the mix of companies classified within a sector.  In addition, while all six of the stocks in our table serve the mining and resources industries, there are differences in what they offer.  Ausenco Ltd (AAX), Leighton Industries (LEI) and the Decmil Group (DCG) offer a variety of engineering and construction services and as such should be, in theory, hit hardest by the contraction in mining expansion projects. 

Imdex Limited (IMD) provides drilling fluids and chemicals; Austin Engineering (AAX) provides heavy equipment; and Ausdrill Ltd (ASL) offers production and exploration services, including drilling.  With the miners cutting back on exploration one would expect ASL to suffer the most amongst that group.  On 07 November Ausdrill’s stock price plunged 24% following a hefty profit warning due to worse than anticipated spending reductions across the mining industry. 

The remaining numbers that can shed some light on potential bargains are the forward-looking estimates, and to a lesser extent past historical performance.  The company that looks most promising is the Decmil Group, having returned a handsome 69% to its investors over the past five years along with a healthy two year growth forecast, despite challenging conditions.  The two year projections are based on Earnings per Share (EPS) estimates while the 5 Year Price to Earnings Growth Ratio (P/EG) is based on anticipated growth rates.  However, both come from analysts and for some small cap stocks that can mean the estimate comes from one or two individuals.  Thomson/First Call reports eight analysts covering Decmil, with three Hold recommendations, four Buys, and one Strong Buy.  The company’s dividend yield is 4.96%, fully franked.

Leighton Industries is definitely worth a look.  While its five year shareholder performance is nothing to be proud of, longer term holders of this stock have fared better.  Here is a ten year chart comparing Decmil and Leighton:

While Leighton has more analyst coverage, the company also has bearish analyst outlook.  Of the 15 analysts covering the stock, two have Sell ratings on LEI; four have Underperform ratings; six recommend Holding the stock; and three have Buy ratings.  Leighton’s dividend yield is 5.96%, 50% franked in FY 2012.

There were three resource miners (excluding gold miners) on the ASX 300 Share Table Summary with P/E ratios under 10.  Here they are:

Company (code)

P/E (06/11)Sector (P/E of 07/11) 
 P/B (MRQ)
 P/S (TTM)
Share Price 
52 Wk % Change5 Yr Total Return 2 Yr Earnings Growth Forecast
5 Yr Est. P/EG
Aquila Resources (AQA) 
3.0
Energy

(13.76)

1.14
N/A
$2.29-3%    -4.6%    --  
-1.01

Fortescue Metals

(FMG) 
9.1Materials

(11.58) 

3.44
2.24
$5.7+46%
23.9%
32%0.58

Mt Gibson Iron

(MGX)
6.5
Materials

(11.58)   

0.9
1.25
$0.99
+35%
24.7%1.6%-6.3%
  

It might come as a surprise that the third largest iron ore miner in Australia appears a clear choice as a potential bargain, based strictly on the numbers.  Fortescue Metals (FMG) is expected to reap ample rewards from its production capacity expansion projects over the last several years.  FMG has the most attractive two and five year growth projections along with a solid history of rewarding shareholders.  Seventeen analysts cover FMG with nine Hold recommendations; five Buy ratings; and three Strong Buy recommendations.  On 06 November UBS upgraded FMG to Buy from Neutral and raised its price target to $6.50 from $5.60. 

Analysts are less enthusiastic about Mt Gibson Iron (MGX) with one recommending Selling the stock; four rate MGX an Underperform; five recommend Holding; and three have a Strong Buy rating.  Nevertheless, despite the more lukewarm analyst view and the meager growth projections, MGX has kept pace with FMG over the past six months.  Here is a price chart comparing the two companies:

Note the rise corresponds to a more promising outlook for the iron ore price.  In a refreshingly candid note dated 18 October, an analyst at UBS acknowledged misjudging the weak iron ore price and Chinese demand.  In short, MGX has benefited from the price of iron ore returning to the U$130 to U$140 per tonne range.  Mt Gibson has a dividend yield of 4%, fully franked, while Fortescue Metals’ yield is about 2%, also fully franked.

Aquila Resources (AQA) mines both iron ore and coking coal and has suffered on both fronts.  While the price of iron ore is healthy, Aquila’s expansion project in the West Pilbara iron ore region is in jeopardy.  The project has been on hold for some time as Aquila’s joint venture partners could not agree on a budget for project completion.  Aquila recently reported it may be looking for a new partner.  The problem is a lack of rail infrastructure, which would be very costly to build. The current completion estimate stands at $7 billion.   Despite this fact there is a lone analyst with a Strong Buy recommendation on AQA, along with three Holds and one Underperform. 

Although there were several gold mining stocks with P/E Ratios under 10, the best of the breed appears to be Medusa Mining (MML).  Here are some numbers for Medusa along with a potential hidden bargain, truck and trailer manufacturer Maxitrans Ltd. (MXI).  Here is the table:

Company (code)

P/E (06/11)Sector (P/E of 07/11) 
 P/B (MRQ)
 P/S (TTM)
Share Price 
52 Wk % Change5 Yr Total Return 2 Yr Earnings Growth Forecast
5 Yr Est. P/EG
Maxitrans Industries  (MXI) 
8.6
Industrials

(10.78) 

1.950.61 
$1.19
+22%    +37.9%  
-- 
--

Medusa Mining

(MML) 
9.1
Materials

(11.58)

1.02 
3.6
$1.85
-66% 
+26.6%
+33.8%0.58

CIMB Securities likes Medusa, recently raising its price target from $7.16 to $7.69.  A total of seven analysts cover the company, with one Underperform; one Hold; three Buys; and one Strong Buy recommendation.  Medusa’s share price has seen the largest drop of any share in the table but has very positive growth prospects both on a two and five year outlook.  Despite the dismal performance of the gold miners over the last few years, Medusa shareholders have seen a 26.6% average annual rate of return over five years.  In contrast, Australia’s largest gold miner, Newcrest Mining (NCM) shows a negative 15.5% rate of return over the same period.  The company operates strictly in the Philippines with a substantial reserve and resource base along with a mining friendly government.  Medusa has seen its share of problems and just completed a capital raise but it should be noted that expectations for Earnings per Share in FY 2014 range from a low of $0.11 per share to a high of $0.40 per share, increasing to a range of $0.21 to $0.60 per share in FY 2015.

Finally, there is Maxitrans, with only two analysts covering the stock – both with Hold ratings – and no discernible growth forecasts.  We focused on Maxitrans because it serves as a good example of the benefit of digging deeper into a promising stock.  For FY 2013 this company saw a 111% increase in NPAT along with a 34% increase in revenue and a 100% increase in dividend payments.  The current yield is 7.1%, fully franked.  This performance is not a “one-year wonder.”  Net Profit after Tax increased from $4.2 million in FY 2011 to $12.3 million in 2012 to $26 million this year.  Dividend payments increased from $0.015 cents per share in 2011 to $0.042 in 2012 and $0.085 in FY 2013.

Maxitrans makes and sells truck-trailer transport equipment.  Acquisitions have expanded the company’s focus to include service repair and parts, with the parts business now accounting for about 35% of company revenue.  Maxitrans management’s stated goal is to increase the parts business to as high as 60% of revenue since parts sales are more defensive in nature than heavy equipment sales.  Perhaps the most promising aspect of this company is the 80% joint venture to grow the transportation and parts business in China.  A larger manufacturing facility in China is scheduled to begin operating in December of 2013 with anticipated revenue increases by Q3 of 2014. 

Click on the links below to read other articles from this week's newsletter

1. 5 Favourite Stocks For Value - Analysts Decide: A key to generating capital gains is to find...

2. 2 Cyclical Stocks Set for Solid Year: A recurring column theme this year has been to...

3. 18 Share Tips - 11 November 2013: 18 Share Tips to BUY, SELL & HOLD from...

4. Searching for Value in Low P/E Stocks: One of the most time-honoured investing...

5. Has the Australian economy turned the corner?: The World Bank identifies an abrupt slowdown of...

6. Futures speculators starting to go long: In recent weeks, speculators have started...

7. The creative economy could fuel Australia's next boom: As we face a slowing of the current boom in...

8. Top 10 shorted stocks: Each day we feature the top 10 shorted stocks...

9. Stocks on a roll: ASX rolling 52-week highs for the previous...

10. Stocks on the slide: ASX rolling 52-week lows for the previous...

 

Please note that TheBull.com.au simply publishes broker recommendations on this page. The publication of these recommendations does not in any way constitute a recommendation on the part of TheBull.com.au. You should seek professional advice before making any investment decisions.



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