When star stocks are under heavy attack from short sellers or mischief makers, it pays to look at who else is in the cross-fire. The market has a habit of driving small companies below their fair value as high-profile problems emerge in their nearest listed competitor.
Consider listed law firms Slater & Gordon and Shine Corporate. Shares in the former tumbled as the corporate regulator questioned the capacity of its auditor to work for a larger, more complex global business, and the British financial watchdog announced it was investigating Quindell plc. Slater & Gordon acquired Quindell’s Professional Services Division (PSD) for $1.25 billion in March 2015.
When Slater & Gordon said it had contacted the Australian Securities and Investments Commission (ASIC) about an accounting error, a selling frenzy ensued and short-sellers gorged on the law firm. It slumped from a 52-week high of $8.07 in April to dumping from $6.50 to $3.50 in just days, wiping more than $1 billion off the market capitalisation.
Chart 1: Slater & Gordon (SGH)
The admission of an accounting error raised questions about Slater & Gordon’s approach to booking work-in-process and, more broadly, its due diligence on the PSD deal and the price paid.
I last wrote about Slater & Gordon in The Bull in June: “There’s enough value now for long-term investors who can withstand short-term price volatility. But Slater & Gordon will probably get cheaper in the next few weeks until there is more clarity on the reliability of the accounts at its $1.25 billion acquisition.” It has fallen from $5 in late June to $3.81.
I still believe the market has over-reacted to Slater & Gordon’s news and that much of the damage was caused by short sellers and others who leaked rumours to drive the price lower. A price fall was warranted, but a 55 per cent drop went too far. Watch Slater & Gordon recover some of that lost ground in the next few months, albeit amid ongoing volatility.
Shine Corporate appears to have been affected by negative sentiment towards Slater & Gordon and may have also been the target of short selling. The Brisbane-based personal-injury firm has fallen from $3.36 in March – just as Slater & Gordon’s problems emerged – to $2.35. Other than news of a taxation dispute, which went in Shine Corporate’s favour, there has been no news to justify a third wiped off the share price.
Chart 2: Shine Corporate (SHJ)
Granted, Shine was due for a correction after soaring from $1.80 at the start of 2014 and was a candidate for profit taking in the sharemarket pullback in June and July. But there seems little doubt that Slater & Gordon’s problems have cast a shadow over listed law firms.
I examined Shine Corporate for The Bull in July 2014 in “One stock that keeps shining“. I wrote: “At $2.35 a share, Shine looks fully valued for now. Its short history as a listed company, and the low number of analysts covering the stock, means a higher margin of safety is required to buy. A key concern is whether profit margins will be maintained as industry competition intensifies and as the mix of services changes.”
I missed the subsequent rally in Shine to $3.36, but it is back to $2.35 and looks reasonable value for long-term investors. Like Slater & Gordon, Shine has bounced in recent days as the market realises that selling in listed law firms has been overdone.
Shine has good growth prospects. Unlike the much larger Slater & Gordon, Shine is focused on the domestic market, its acquisitions are modest by comparison, and there is less risk – although less upside, given the great promise of Slater & Gordon’s UK business.
Shine posted a strong result for the first half of 2014-15. Revenue grew 29 per cent over the previous corresponding period and underlying earnings jumped 24 per cent. Excellent revenue growth in its emerging practice areas was a highlight.
All five broking firms that cover Shine have a buy or strong buy recommendation, according to Thomson/First Call consensus analyst forecasts. Price targets range from $3.06 to $3.60 and the mean forecast is $3.42 – or more than $1 above the current share price.
The share valuation tool Skaffold believes Shine is trading at 14 per cent below its intrinsic or true value, but does not predict large increases in value in the next three years.
Clearly, the listed law firms can mount a case that they have been oversold. Slater & Gordon has the most upside when sentiment stabilises, but also the most risks, given the price of its UK acquisition.
By comparison, Shine Corporate looks a lower-risk way to play a recovery. It may take time as the market digests Slater & Gordon’s problems and unwinds law-firm valuations that had run too far, too fast. But the business model, industry fundamentals and long-term growth prospects for both firms have not changed.
Tony Featherstone is a former managing editor of BRW and Shares magazines. This column does not imply any stock recommendations or offer financial advice. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis at July 16, 2015.