The classic investment trap – confusing price with value – often snares Initial Public Offering (IPO) investors. A float that rallies after listing is perceived as “high quality”. Another that falls below its issue price is discarded. The result: investors buy overpriced stocks and ignore cheap ones.
I am always wary of IPOs. Having analysed hundreds over the years for financial newspapers and magazines, I’ve seen too many overvalued companies come to market. Many are best bought a year or two after they float, when there is more history as a listed company.
Deciding if a float is good or bad, within months of listing and based mostly on price, is dangerous. A poor-quality float might rally after listing because its vendors and promoters engineered a scarcity of stock at listing. Now 30 per cent above its issue price, and badly overvalued, the float receives plaudits and attracts new buyers.
Meanwhile, high-quality companies that were fully valued at listing, or that listed when the broader sharemarket was falling, sink below their issue price. An impatient market quickly writes them off as overvalued and opportunistic, yet their stock is a screaming buy.
It is amazing how quickly investors relegate fallen IPOs to the doghouse. Everybody wanted a piece of the float when it was valued at $200 million and media and broker reports were plentiful. Then the stock slumps and you hardly hear a peep – perfect conditions for the smart money to move in.
Of course, most IPOs are overvalued at listing as vendors look to take advantage of sharemarket conditions and achieve higher valuations. Plenty deserve to fall after listing. Micro-cap exploration stocks, in particular, quickly lose support if they tumble below the issue price.
IPOs such as iSelect and McAleese that disappoint the market within months of listing, even if from a transport accident, in McAleese’s case, deserve all they get. It is hard to buy any stock when the prospectus seems more fact than fiction within just a few months of listing.
Even so, it is dangerous to form a view on stocks based on price action because a) the market often gets its wrong with valuations of newly listed companies, and b) what matters most is how the share price compares with intrinsic value and whether there is a sufficient margin of safety to buy.
Yet there was much commentary last year about early share-price falls signifying an overvalued, overheated IPO market. Nine Entertainment Co Holdings fell below its issue price after listing, so therefore was aggressively overvalued at listing, according to some media reports. Travel insurer Cover-More Group’s “disappointing” debut signalled a slowing IPO market.
I recently analysed the interim profit results or trading updates for the 10 largest IPOs from 2013, by market capitalisation. Most met or exceeded prospects forecasts. Education provider Vocation, covered in this column recently, rallied when it beat market forecasts.
My interest, however, is just as strong in IPOs from 2013 and early 2014 that have fallen below their issue price.
Six floats warrant further investigation: Dick Smith Holdings, SG Fleet Group, Mighty River Power, Pact Group Holdings, iSelect and McAleese Transport. I have not followed New Zealand-based floats Meridan Energy and Z Energy closely enough to form a view.
Dick Smith raised $344 million and listed at $2.20 a share in early December. Several fund managers were wary of Dick Smith’s private equity ownership and felt it had come to market (Woolworths previously owned it) too soon. It now trades at $2.05.
But the electronics provider beat its first-half 2014 underlying earnings forecast by 4 per cent, thanks to higher-than-expected margins and cost control, and achieved 58 per cent of its full-year earnings forecast in the half. After recent price falls, it looks slightly undervalued for long-term investors.
New Zealand electricity provider Mighty River Power also looks a touch undervalued at current prices. It listed on ASX in May 2013 after raising $1.35 billion at A$2.01 a share. It slumped to $1.76, and recovered to $2.04
I like Mighty River. It produces about 17 per cent of New Zealand’s electricity output, has operated in a favourable regulatory environment, and has a 5.6 per cent trailing yield at the current price, albeit with franking-credit complications for Australian investors who do not have NZ income.
Mighty River recently reaffirmed its 2013-14 guidance, in drought-affected conditions. This utility can tick higher this year, and suits long-term income investors seeking higher-yielding defensive stocks in their portfolio.
SG Fleet Group, one of few industrial companies to list this year, raised $188 million at $1.85 a share, and debuted in March. Shares in the vehicle-leasing business have eased to $1.72, after falling as low as $1.61. SG Fleet is a quality company that should have a spot on portfolio watchlists. It will be near value territory if it revisits its previous low.
Of the rest, it is too early to buy iSelect, McAleese or Pact Group Holdings, even though their valuations are sharply lower. Better to leave the early part of their recoveries, which will eventually happen, to contrarian investors prepared to take high risk.
iSelect has some attractions. Hefty fee increases this year for health-insurance policies will surely send more people scurrying to insurance-comparison sites to find a better deal. iSelect has an interesting position in a challenged health-insurance market, but remains overvalued, as I wrote last week.
Only deep contrarian investors would buy McAleese, given its operational and balance-sheet risks, even though it “looks” cheap on several valuation metrics. Traders should watch for a base to be formed in McAleese and pounce on any significant share-price breakout, when the point of maximum pessimism in the stock passes. It is one for speculators at this stage.
Pact Group Holdings, 2014’s largest Australian IPO by capital raised, had slight revenue and earnings growth, and confirmed full-year forecasts in its latest result. The plastic-packaging manufacturer has fallen to $3.45, from a $3.80 issue price, after seeking $649 million and listing in December.
It is hard to find a catalyst to re-rate Pact this year, given sluggish industry conditions.
For now, Dick Smith and Mighty River are the best of the IPOs trading below their issue price. SG Fleet Corporation is also worth watching, in anticipation of improving value.
Tony Featherstone is a former managing editor of BRW and Shares magazines. The column does not imply any stock recommendations. Readers should do further research of their own or talk to their financial adviser before acting on themes in this article. All prices and analysis at March 25, 2014