Somebody forgot to tell a few ASX-listed companies about the parlous state of Australia’s manufacturing sector. Maxitrans Industries, Supply Networks and Codan are performing strongly, and a few others sector laggards look ripe for a re-rating.
That is not to downplay manufacturing problems, or the damage from a stubbornly high Australian dollar to the export sector. An AIG Group survey in February found more than half of the 350 respondents expected general business conditions to deteriorate this year.
There are bright spots. Maxitrans, a maker of trailer and truck parts, has soared from a 52-week low of 34 cents to $1.38. It posted a cracking half-year result in February: revenue up 42 per cent to $189 million, and underlying after-tax net profit up 111 per cent to $12.9 million.
Maxitrans is benefiting from strong demand from the resource sector for its trailers and tippers, and rising sales in its aftermarket parts and service business as transport companies catch up on post-GFC parts replacements. Several small acquisitions are also driving growth and creating greater scale for the well-run company.
Maxitrans has started the year in good shape: its order book is up 5 per cent on the same time last year, and order enquires and quotation activity was strong in January. It expects its second-half net profit to be similar to the first half, which explains the surge in its share price this month.
Even so, Maxitrans is a work in progress. The small cap’s return on equity (ROE) fell from 17.7 per cent in 2007-08 to 4.6 per cent in 2010-11. It recovered to 12.6 per cent last financial year, but even that is too low given Maxitran’s potential.
Current earnings momentum suggests Maxitrans can get its ROE above 20 per cent in the next few financial years – and cement its growing reputation as a star small stock.
A smaller truck parts distributor, Supply Network, has rallied from a 52-week low of 83 cents to $1.55, and like Maxitrans, is benefiting from stronger demand for replacement parts.
Supply Networks forecast 10.8 per cent revenue growth to $32.7 million for the half to December 31, 2012, and a full-year earnings before interest (EBIT) forecast of about $6 million, which would be in line with the FY12 result. Relocation costs in New Zealand and Perth will affect its second-half result.
Supply Networks has sharply highly ROE compared with Maxitrans. From a low of 3.9 per cent in FY07, its ROE raced to 13.2 per cent in FY10, and 24.5 per cent in the latest full-year result. Debt is negligible and the number of issued shares has remained unchanged in the last two financial years.
It is always a good sign when small-cap companies go against the trend and outperform in weak markets. A rising ROE is often a precursor to a company’s rising intrinsic (or true) value and a higher share price. Low debt gives Supply Network scope to expand through acquisitions.
Neither stock looks cheap after recent price gains, and Supply Network’s low liquidity is another consideration. Of the two, Maxitrans looks the better bet for investors with a medium-term perspective.
Another manufacturer, Codan, is also making strong gains. It designs and manufactures communications, metal-detection and mining equipment, and printed circuit boards. Codan has soared from a 52-week low of $1.24 to $3.49 amid strong earnings growth.
Half-year revenue rose 83 per cent to $159 million, and underlying net profit increased a whopping $10.4 million to $27.4 million. Codan expects the second half to be as strong as the first, which implies another excellent full-year result in a difficult market.
Its debt-to-equity ratio was a modest 14 per cent in the first half, and the ROE was outstanding: 50 per cent in the first half of FY13. A full-year ROE of 48 per cent in FY10, 34 per cent in FY11, and 37 per cent in FY12 is a stellar performance.
High and rising ROE and falling debt are a terrific combination, for it suggests management is working each dollar of shareholder equity hard, without having to grow through excessive borrowings or share issuance that dilutes shareholdings and weighs on ROE.
Even after strong price gains, Codan is on a forecast Price Earnings (PE) multiple of 11 times, according to consensus analyst estimates, which hardly seems excessive given its growth potential.
Codan’s strong performance has not rubbed off on Legend Corporation, another technology manufacturer. Legend’s one-year total shareholder return is minus 11 per cent. Its net profit for the half fell 37 per cent to $3.1 million due to higher overheads and depreciation costs. Sales revenue was slightly lower at $51.6 million in a disappointing result.
Legend is in transition as it focuses on the electrical, power and infrastructure segments and shrinks its electrical solutions business. It is reinvesting in higher-growth business and expects a stronger second-half performance. The small-cap company is clearly laying a platform for faster medium-term growth, but turnarounds so often take longer and cost more than management suggests.
Still, Legend is worth watching in the second half for signs that its transformation is translating into stronger profit growth, higher ROE, and ultimately an improving valuation.
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Tony Featherstone is a former managing editor of BRW and Shares magazines. All prices and analysis at Feb 14, 2013. The author implies no stock recommendations from the above commentary. Readers should do further research or talk to their financial adviser before acting on themes in this article.