A key to generating capital gains is to find undervalued stocks.
Investors, for a myriad of reasons, are good at sending share prices far beyond fair value or belting them down way too low. Today, five leading market analysts choose a single stock they believe offers good long term value and the reasons why investors could consider adding them too their portfolios.
Sleep disordered breathing affects about 20 per cent of the population, according medical devices maker ResMed, a firm that grew from humble beginnings in Sydney in 1989 to become a global leader in treating obstructive sleep apnoea (OSA) and other respiratory disorders.
However, awareness is low and ResMed estimates about 90 per cent of people who have OSA remain undiagnosed and untreated.
Analyst Scott Marshall, of Shaw Stockbroking, says ResMed’s forecast price/earnings ratio has been recently trading at a 40 per cent premium to the market average of 14 times.
“This valuation premium means that any disappointment from the company exposes the shares to sudden price falls,” he says.
“This happened after ResMed released its first quarterly update for 2014. The share price fell about 20 per cent.”
Marshall says adjusting for currency movements, first quarter revenue increased by only 4 per cent to $US357.7 million on the previous corresponding period.
“This is not the growth profile demanded by the market for a stock trading at a 40 per cent P/E premium to the broader market,” he says.
Marshall says increasing competition in the airflow generator and facemask markets pressured revenue. But ResMed’s new generation of facemasks are selling well in Europe and should help ResMed regain earnings momentum. Marshall says ResMed must keep finding new markets to justify its premium.
“Stocks priced for perfection leave little room for error,” he says. “A company has to meet expectations, or the share price will be punished. However, ResMed has a good track record of generating growth over the longer term.”
Lynas Corporation (LYC)
This rare earths producer reported a net loss of $143.56 million for full year 2012/2013. The company has been plagued by operational problems at its Malaysian processing plant. Environmentalists and residents have raised health concerns about storing waste. The company says there are no health risks.
Darren Jackson, of Calibre Investments, says Lynas is a single commodity stock and its fortunes can be easily influenced by external factors. Rare earths are plentiful and prices have been declining.
“Additionally, there’s been ongoing country and legal risk involving its controversial Malaysian refining plant,” he says.
Jackson says Lynas should focus on becoming the lowest cash cost rare earths producer in the world.
“By slashing costs, Lynas can potentially increase its margins and better withstand the current low price environment,” he says. “Be willing to stockpile, reduce production, forward sell and become a trader of rare earths. The more successful Iluka Resources operates in this manner and is highly responsive to changes in the market.”
Jackson says Lynas isn’t a stock for the risk averse. The shares were trading at 36 cents on November 6, 2013. In August 2011, the shares were priced above $2. Jackson says Lynas is a punt on rare earth prices increasing and the company overcoming operational efficiencies.
Newcrest Mining (NCM)
Asset impairment and writedowns of $6.2 billion contributed to a statutory loss of $5.77 billion for the 12 months to June 30, 2013. Earnings before interest and tax of $756 million were down 52 per cent on the previous corresponding period.
James Samson, of Lincoln Indicators, says poor operational performance and declining gold prices also contributed to Newcrest’s decline. He says cost control is the company’s main focus. It plans to cut 2014 capital expenditure to $1 billion and hasn’t ruled out further reductions should gold price volatility persist.
He says the Lihir project is key to turning round NCM’s performance, with its largest asset expected to contribute a third of total production. “The company is off to a better than expected start this financial year, with first quarter production at 586,000 ounces, which would be at the upper end of guidance on an annualised basis,” he says. “Encouragingly, costs were also down for the quarter, from $A1283 an ounce to $A1093 an ounce.”
Atlas Iron (AGO)
Produces iron ore at Pardoo, Mt Dove and Wodgina in Western Australia.
Peter Moran, of Wilson HTM, says Atlas Iron’s underlying net profit after tax of $13.7 million in 2012/13 was disappointing and well below consensus of $49 million and Wilson HTM expectations of $26.6 million. Lower than expected revenue and higher financing costs were to blame.
Moran says the company shipped 7.4 million tonnes of iron ore in 2012/13. He expects Atlas to ship 10 million tonnes this financial year.
Moran says catalysts that would drive a higher valuation include exploration success at its Horizon II project, an equity sell down of its McPhee Creek project, a higher iron ore price and access to rail infrastructure.
WHITEHAVEN COAL (WHC)
The coal producer has acknowledged a difficult 2012/13 after reporting a net loss of $82.2 million. Low coal prices and a relatively high Australian dollar made market conditions difficult. The share price has fallen from $3.60 levels in January this year to trade at $1.55 on November 6. The company believes its outlook is brighter as it transitions from a 4 million tonne producer to a 23 million tonne producer, courtesy of mine development.
Les Szancer, of Blueribbonoptionsonline.com, has faith in the Whitehaven story and the coal sector generally. He notes an International Energy Agency report saying global demand for coal continues to escalate. The report claims coal will come close to surpassing oil as the world’s top energy source by 2017.
“That doesn’t sound like a dying industry to me,” Szancer says. “In my view, Whitehaven’s share price has been beaten down to a good buying opportunity for those who believe coal has a bright future.”
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