Rudi’s View: Growth Versus Value This Reporting Season

This story features MCMILLAN SHAKESPEARE LIMITED, and other companies. For more info SHARE ANALYSIS: MMS

(This story was originally published on Wednesday, July 27, 2011. It has now been re-published to make it available to non-paying members at FNArena and to readers elsewhere).

By Rudi Filapek-Vandyck, Editor FNArena

The irony of the share market is that companies that achieve the highest growth do not necessarily deliver the highest returns. It's a hard lesson to be confronted with and I am certain many investors can relate to it.

One of the key elements that will determine future investment returns is what has been priced "in" or "out" already – a fact too often forgotten by investors jumping from one good news story to the next one.

This week saw two companies stepping into the limelight in Australia which I believe, combined, illustrate the key dilemma's for investors looking to increase their exposure to equities throughout this reporting season. On one hand we have Campbell Brothers ((CPB)), one of about a hundred listed companies that should benefit directly from increased spending by miners and energy companies. On the other hand we have Alesco (ALS)), a company that has been forced to sell off underperforming operations and to repay debt and repair the balance sheet. Most importantly, Alesco sells specialty products and equipment for construction and decoration, and right now the building sector in Australia and New Zealand is not exactly booming.

This week the sharp differences between the two opposites were highlighted once again.

Campbell Bros is a good, well-run, solid company with a very promising outlook. You don't have to take my word for it, simply look at the performance of the shares over the past seven months. Whereas the share market has been up and down sharply, pushing most stocks in the market to lower levels than at the beginning of the year, Campbell Bros shares have successfully avoided most of the selling pressure and volatility. Sure, the share price briefly rose above $48 last month, but all in all the price chart shows a steady advance from $40 to $47 since early January and this steady outperformance was justified this week as the company board surprised shareholders at the AGM with an upgrade to profit guidance, only four months into the new financial year (Campbell operates on a fiscal year to March 31).

Stockbroking analysts found themselves scrambling to add extra to their growth expectations and as things stand right now, earnings per share (EPS) are expected to jump by no less than 37% this year. Note this high growth number follows after a red hot fiscal 2011 during which growth accelerated by no less than 57%. In case there are still doubters out there: Campbell Bros is flying high and the share price performance so far this year suggests this has not gone unnoticed.

Note, I don't believe the share market is always telling us an accurate story, but when the market overall goes through a slump and shares put in a low volatile, solid performance like Campbell Bros shares have, I believe this is more often than not the hallmark of a rock solid growth story. There are others, of course, that stand out in similar fashion, such as McMillan Shakespeare ((MMS)), Monadelphous ((MND)) and RCR Tomlinson ((RCR)). I should also mention Woolworths ((WOW)), though Woolies does not genuinely belong to the same category of high growth stocks (more about Woolies another time, or look at bottom of today's story).

Symbolising the sharp divide in corporate Australia post GFC, Alesco released a financial performance in line with market expectations, after divestments and balance sheet repair. The company surprised by paying out a bonus 5c in special dividends, on top of the regular 8.5c for fiscal 2011 -substantially increasing the dividend yield- but it was mild relief only for loyal shareholders as the share price thus far lost more than 12% and that is just this year. It's hard to fathom today, but in late 2007 Alesco's share price reached as high as $14. (The shares closed at $2.88 on Wednesday).

All management could talk about was how tough things are out there for a company that is looking to sell automated garage doors and windows right now. The response by stockbroking analysts was commensurate: EPS and dividend estimates for the years ahead have been scaled back. The next six months are going to be tough, but maybe things will start looking better from next calendar year onwards?

If the latter is true than Alesco shares will prove a much better investment than Campbell Bros, even though the latter is flying and the former can only see clouds and an uphill path foward. This is because investors have already priced in a lot of growth in Campbell Brothers shares and they have virtually priced out any growth in the case of Alesco.

I could insert a few paragraphs with some wizz-bang mathematical calculations to prove my point, but I'd risk losing your attention. So maybe the best way to illustrate the difference is by referencing to the respective consensus price targets. Campbell Bros shares are currently trading about 5.5% below consensus target while carrying an implied dividend yield of 3.9%. This is far from bad for a stock that is trading on circa 17x times next year's profits otherwise known as the forward PE ratio. Combine the two and we're talking about 10% in total return, which seems a bit of a disappointment for a company that is doing as well as Campbell's.

Alesco, on the other hand, is trading more than 16% below consensus target and the implied dividend yield this year is 6.4%, expected to jump to 8.5% in FY13.

The problem is that with another tough six months ahead, there remains plenty of scope for more delays, even worse times, more disappointments and further losses for the share price. In a worst case scenario, what is penciled into today for the next two years could disappear completely the moment management would come out with a severe profit warning a la David Jones ((DJS)). Because of this risk, the Alesco share price is not going to close the gap with stockbroker price targets anytime soon. Watch out though from the moment Alesco management turns more positive about the outlook and investors see enough they can believe in.

This reporting season, there will be many Campbells and many more Alescos. In the current context, one can only acknowledge the shorter term risks are firmly in favour of the Campbells. And it has to be pointed out, with the wind blowing in their back, these companies can still surprise to the upside in the year ahead, which should then translate into higher forecasts, higher targets and a higher return.

In both cases, however, "timing" remains important, which according to my analysis is closely linked to "valuation". To put things in a different perspective: Campbell shares were already trading at $48 in April, which was arguably too expensive at the time. So even with such a good growth story, making sure you're not jumping on the bandwagon at too high a share price remains all-important, especially for those investors looking to add to their long term portfolios.

The problem with "value" stocks such as Alesco is, however, that nobody can guarantee when the current slow down for the Australian economy and its weakest parts will turn around for the better. The Australian dollar hit 1.10 against a weak USD today. The Reserve Bank remains in tightening mode. One thing that still stands out is, in case investors' timing proves too early, there's always a dividend return to make waiting for the turnaround easier. This does not apply for stocks that come out with a shocker, a la David Jones (as we've all witnessed).

With regards to Alesco in particular, I note the share price has started rising since the FY11 release and Commonwealth Bank recently became a substantial shareholder.

Investors should note "Alesco" in the story above can easily be replaced with GUD Holdings ((GUD)), Fleetwood ((FWD)), Bank of Queensland ((BOQ)), Lend Lease ((LLC)) and many, many others. The trick this reporting season will be to separate the David Jones's from the true value stories, while those with a shorter term focus will be chasing the Campbells (as they should).

****

Colleague Greg Peel and myself will be broadcasting our second Market Insight tomorrow (Thursday, 28th July 2011) from 4pm. Those who want to experience the broadcast live,can do so via the following link:

http://www.brr.com.au/event/82650

Also, I will be presenting during the upcoming Trading and Investing Expo in Sydney (Aug 5 and 6) as well as to ATAA members and guests in Newcastle (Saturday, August 13).

For more info about the Trading and Investing Expo presentations see

http://www.tradingandinvestingexpo.com.au/speakers/rudi-filapek-vandyck-sydney-2011/

The ATAA presentation will take place at the Kahibah Bowling Club, 63 Kenibea Avenue, Kahibah (near Charlestown) between 11.30-3pm (luncheon break in between) on Saturday, August 13.

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions.)  

P.S. I – All paying members at FNArena are being reminded they can set an email alert for my Rudi's View stories. Go to Portfolio and Alerts in the Cockpit and tick the box in front of 'Rudi's View'. You will receive an email alert every time a new Rudi's View story has been published on the website. 

P.S. II – P.S. Investors who'd like to re-read my Woolworths analysis from last year, see "It's A Bubble! (But Not The One You Think)"

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