Few things smash share prices harder than a downgrade to prospectus forecasts. The market loathes companies that backpedal on forecasts in their maiden year as a listed entity.
Such companies quickly lose credibility and sometimes never get it back. Often, vendors squeeze every dollar out of projected earnings to inflate the company’s sale price. Unsuspecting buyers do not pay enough attention to assumptions behind the projections.
I liken it to selling a house. A couple might defter house maintenance because they intend to sell. The buyer gets a house that needs more investment than they realised.
Companies hurtling towards an Initial Public Offering (IPO) sometimes defer expenditure to pump up earnings. Every extra dollar of projected earnings is magnified by the IPO’s valuation multiple, so vendors (especially those selling out) are incentivised to boost earnings.
Some private-equity firms are notorious for leaving nothing on the table for other investors when they sell their stake in a company through an IPO. Always take extra care when private-equity firms are involved in IPOs; valuations can be aggressive.
The maiden full-year result says a lot about the IPO, its management and vendors. The result tells investors whether the prospectus was fact rather than fiction and if management understands the company’s market and has sufficient skill to make and meet projections.
The result also sets the tone for the company. Investors want to know that the company has done what it said it would in the prospectus and treats all shareholders fairly.
Yes, there are times when companies miss prospectus forecasts because of factors beyond their control: unfavourable currency movements, for example. The problem is when revenue and earnings forecasts were unrealistic, to get the IPO away.
Much is at stake. Apart from the organisation’s credibility, there are significant legal risks if the prospectus is later proved to have been false.
Also, IPOs that get smashed within months of listing because of prospectus-forecast downgrades struggle to regain the market’s attention. The first year as a listed company is no place for rollercoaster performance that upsets the market.
A long list of IPOs over the years have disappointed investors with prospectus downgrades, some within months of listing. For example, real-estate business McGrath was smashed when it downgraded prospectus forecasts within a year of listing. Healthy fast-food chain Oliver’s Real Food is another recent IPO that backpedalled on IPO forecasts.
Thankfully, a few IPOs have gone the other way, upgrading prospectus forecasts in difficult market conditions and deservedly enjoying share-price gains. Here are two:
Kogan is one the standouts so far in the current earnings-reporting season. The electronics retailer upgraded earnings forecasts three times in the past year, beat prospectus revenue forecast by 20 per cent and more than quadrupled net profit over the year.
Kogan raised $51 million in July 2016 through an IPO at $1.80 a share. The stock has raced to $3.13 and jumped about 10 per cent after its maiden full-year result.
Kogan’s performance is more impressive against a backdrop of one retailer after another being smashed this year amid paranoia about Amazon’s ramp-up in Australia. Few retailers are as exposed to Amazon as Kogan, which has built its business on e-commerce.
Market expectations have risen sharply for Kogan, meaning it must keep delivering rapid growth to maintain the valuation or spark the next share-price re-rating. Some broking firms that cover Kogan have targets around $3, meaning the stock is fully valued.
I wouldn’t chase Kogan higher at these levels. Although the company’s performance impresses, retailing conditions remain tough, consumers are under pressure and Amazon’s expansion in Australia is a formidable threat. Kogan is due for a share-price pullback or consolidation as market interest in its excellent full-year result subsides.
Value investors who are comfortable with micro-cap stocks should watch and wait for better value. Kogan deserves its gains; it’s one of a small group of companies this earnings season that trumped market expectations. But the price may have run too far, too fast for now.
Chart 1: KoganSource: The Bull
2. Inghams Group
The nation’s biggest chicken producer had a rocky time in the lead-up to its float and in the early aftermarket. Inghams’ private-equity owner, TPG, had to scale the IPO’s issue price back to $3.15 after investors baulked at initial valuations.
Inghams raised $596 million and listed in November 2016. After a lacklustre start – the shares fells to $3.02 in early March – Inghams has rallied to $3.42.
Inghams reported pro-forma after-tax net profit of $102 million for FY17, up 23 per cent on the previous period and ahead of the $98.9 million prospectus forecast. A 9.5 cent dividend was ahead of market forecasts. Cash flow and debt reduction also beat market expectation.
All up, Inghams delivered a solid rather than spectacular result. The company continues to see steady growth in FY18 as its cost-cutting initiatives improve profit margins. The main negative was higher energy costs adding up to $20 million over two years on some broker forecasts – an outlook that weighed on Inghams’ share price after the result.
I like Inghams’ long-term prospects. Australians continue to eat more chicken over other meats, poultry conditions in New Zealand are stabilising, and Inghams’ efficiency program is delivering good gains.
Moreover, production economics in poultry continue to improve due to better breeding and feeding techniques, and Inghams has potential to move higher up the supply chain through value-added products (such as crumbed chicken) that offer better margins.
At $3.42, Inghams is on a forecast Price Earnings (PE) multiple of about 11 times in FY18 and yielding 5.9 per cent, fully franked, on Macquarie’s estimates. That is undemanding for a company that has a strong position in a large, albeit mature market.
Beating the maiden prospectus forecasts adds to perception that Inghams is well run, has a clear strategy for growth and is doing what it said it would in the prospectus.
Chart 2: Inghams GroupSource: The Bull
• Tony Featherstone is a former managing editor of BRW and Shares magazines. The information in this article should not be considered personal advice. The article has been prepared without considering your objectives, financial situation or needs. Before acting on the information in this article you should consider its appropriateness, regarding your objectives, financial situation and needs. Do further research of your own or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at August 24, 2017.