Small Caps With Upside

This story features DOMINO'S PIZZA ENTERPRISES LIMITED, and other companies. For more info SHARE ANALYSIS: DMP

By Chris Shaw

Last week Morgan Stanley identified a number of smaller capitalised stocks it believed offered value and this week it has identified some more companies where it sees upside. The broker has initiated coverage with Overweight ratings on ASG Group ((ASZ)), Domino's Pizza Enterprises ((DMP)), Bradken ((BKN)), Fantastic Holdings ((FAN)) and Monadelphous ((MND)). In each case the rating compares to an In-Line industry view.

One attraction of ASG for Morgan Stanley is it offers a defensive exposure in the IT services sector from a majority of government clients. As well, there is leverage to operating expenditure rather than the more cyclical capex spending end of the market.

Earnings are therefore of a high quality, with Morgan Stanley expecting earnings to grow both organically and via acquisitions given a strong balance sheet. Net debt to equity currently stands at around 5% on the broker's numbers.

On Morgan Stanley's numbers the company should deliver a capitalised annual growth rate in net profit of 13% through to FY13, while return on invested capital is expected to rise from 4.2% now to 21.2% in FY12.

The company generates solid cash flow as evidenced by a free cash flow yield of 10%, so Morgan Stanley sees the current 4-5% dividend yield as sustainable. Its Overweight rating is accompanied by a price target of $1.60. Currently no brokers in the FNArena database cover ASG Group.

For Domino's Pizza it is the European operations that hold the key in Morgan Stanley's view, as the Australian operations are the solid base and Europe is the blue sky as the group's footprint is expanded.

This is important as Morgan Stanley suggests as the group expands its scale in the European market margins will improve, which in turn will support sustained momentum in system sales both overseas and in Australia.

Morgan Stanley's forecasts call for strong double-digit earnings growth in coming years, as evidenced by its earnings per share (EPS) estimates of 26c this year, 32c in FY11 and 37c in FY12. Consensus EPS forecasts according to the FNArena database stand at 26.2c this year and 31c in FY11.

The average price target for Domino's according to the database is $5.70, well below the Morgan Stanley base case target of $7.30. Under a more bullish scenario Morgan Stanley can justify a valuation of $8.60. FNArena shows Domino's is rated as Buy three times, Accumulate once and Hold twice.

Given the company offers exposure to the resources and energy sector through the supplying of various products and to freight via its rail division, Morgan Stanley likes the potential for Bradken given its expectation activity levels will pick up through FY11 and beyond.

Earnings in FY10 are expected to be flat but in FY11 Morgan Stanley expects growth of better than 30%. Further upside is expected in FY12, even assuming little increase in capital expenditure or acquisitions as volumes and revenues in the company's businesses should move higher as economic growth picks up. Its base case numbers suggest revenues increase by around 10% per annum over the next two years.

Morgan Stanley is forecasting EPS for Bradken of 50c this year and 66c in FY11, while consensus numbers according to the FNArena database are 51.4c and 62.7c respectively. Bradken is rated as Buy six times and Hold twice, with an average price target of $8.00. Morgan Stanley's target stands at $9.50.

As with Domino's Pizza, Fantastic Holdings is also looking to grow its store base, this while also looking at strategic acquisitions and investing in its supply chain capabilities. To Morgan Stanley this means the company is setting itself up to come through the current retail spending cycle with a bigger and much improved business and one that offers significant leverage to earnings.

On Morgan Stanley's numbers, Fantastic should generate robust double-digit growth rates, its forecasts calling for EPS of 25c this year and 29c in FY11. Consensus estimates according to the FNArena database stand at 25.5c and 30c respectively. The database shows two Buys and one Hold rating and an average price target of $4.77, while Morgan Stanley's target is $4.85.

Engineering group Monadelphous offers a premium exposure to Australia's resources boom in Morgan Stanley's view, as along with iron ore supply operations the company continues to expand in the oil and gas, coal, water and infrastructure markets.

This broadening of operations gives Morgan Stanley increased confidence growth can continue through and beyond the current strong resources cycle. Even allowing for a slight but steady erosion in operating margins, earnings should expand through at least FY12.

Morgan Stanley's EPS forecasts stand at 89c this year and 99c in FY11, while consensus forecasts in the FNArena database stand at 92.4c and 103.6c. The database shows the stock is rated as Buy twice and Hold five times with an average target of $15.86, while Morgan Stanley's target is $18.00.

Elsewhere in the smaller cap end of the market Macquarie has Boart Longyear ((BLY)) as one of its Marquee Ideas stocks given strong operating leverage to a recovery in the global minerals exploration spending cycle.

Recent comments from management indicate Boart is enjoying a strong turnaround in activity levels, leading Macquarie to suggest there is potential for revenue expectations to be upgraded at the company's annual meeting next month. The broker's numbers reflect this as Macquarie is forecasting revenue growth of 22% against current guidance of 15%.

Macquarie's target on Boart is $0.40, while the average target according to the database is $0.38. Including Macquarie's Buy the stock is rated as Buy six times, Accumulate once, Hold twice and Sell once.

The other stocks to make Macquarie's Marquee Idea's list are Commonwealth Bank ((CBA)), News Corp ((NWS)), Qantas ((QAN)), Rio Tinto ((RIO)) and Westpac ((WBC)). All are rated as Outperform except Westpac, which is rated as Neutral.

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