Seeking Value Among Emerging Companies

This story features INVOCARE LIMITED, and other companies. For more info SHARE ANALYSIS: IVC

By Chris Shaw

As brokers continue to look for pockets of value in the Australian equities market, Morgan Stanley has initiated coverage on an additional 10 emerging companies. These companies offer exposure to a range of industries including consumer, mining services, media and IT services.

The 10 companies are Automotive Holdings ((AHE)), Invocare ((IVC)), Mermaid Marine ((MRM)), Mineral Resources ((MIN)), Mitchell Communications ((MCU)), Navitas ((NVT)), Oakton ((OKN)), The Reject Shop ((TRS)), SMS Management & Technology ((SMX)) and Super Cheap Auto ((SUL)).

Out of these companies Morgan Stanley rates all as Overweight with the exception of Oakton, to which it ascribes an Equal-weight rating. The broker has an In-Line industry view, which suggests relative performance for the emerging companies universe will be in-line with that of broader market benchmarks.

Among the 10 companies, Morgan Stanley suggests on a risk-reward basis the three stocks with the most implied upside relative to base case valuations are Mineral Resources at 69%, Automotive Holdings at 28% and Mitchell Communications at 26%.

Applying bull-case valuations the results are a little different, as on this basis Morgan Stanley estimates the top three upside scenarios come from Minerals Resources and Automotive Holdings again at 141% and 61% respectively, while Navitas also makes the list at 65%.

Integrated mining services and processing company Mineral Resources is seen as expanding its operations in coming years, largely through higher volumes rather than higher prices. Also attractive to Morgan Stanley is the three businesses within the company have defensive characteristics, which suggests limited downside even when the resource cycle turns out less positive.

Morgan Stanley's price target for Mineral Resources is $13.00 and this is well above the $8.19 target of Macquarie, the only broker in the FNArena database to cover the company. Macquarie similarly rates Mineral Resources as Outperform.

For Automotive Holdings, Morgan Stanley suggests the market is likely to be attracted to the combination of a resilient business model delivering solid earnings growth, with upside for additional growth via both investment and acquisition.

To reflect its positive view on Automotive Holdings, Morgan Stanley has set its price target at $3.40, which compares to an average target according to the FNArena database of $2.90. The database shows the three other brokers with coverage all rate Automotive as a Buy.

The FNArena database shows only GSJB Were covers Mitchell Communications, rating it as a Buy with a price target of $1.15. Morgan Stanley's target of $1.10 is close to this, its forecasts calling for annual capitalised growth in earnings of 13% through to 2013.

The attraction of Mitchell, according to Morgan Stanley, is the company is Australia's largest media buying agency and offers a cheap exposure to strong growth in online advertising. On the broker's numbers Mitchell is trading at a 30% discount to the market.

In recent years Navitas has made a number of acquisitions and diversified its income streams, while also establishing an offshore presence in the education market. Morgan Stanley anticipates solid double-digit earnings growth and expects as the market becomes more comfortable with this outlook, it will be more willing to pay up for the stock.

Morgan Stanley's price target for the stock is $6.50, which is well above the average price target according to the FNArena database of $4.81. Of the seven brokers to cover the stock, only Macquarie rates Navitas as Outperform at present, compared to six Hold ratings.

Funeral service provider Invocare ((IVC)) is another stock offering defensive growth according to Morgan Stanley, while the strength of the business model should allow for earnings growth of solid single digits in coming years.

The other attraction for Morgan Stanley is the attractive yield, which is more than 5%. The broker has set its target at $7.00, broadly in line with the average target according to the FNArena database of $6.87. Seven brokers in the database cover Invocare, with three Buys and four Hold ratings.

Marine services group Mermaid Marine remains undervalued in Morgan Stanley's view, as the stockbroker sees additional upside as the group's fleet is expanded and renewed and the Dampier supply base turns into an earnings generative asset.

Supporting Morgan Stanley's expectation of solid earnings growth is Mermaid's exposure to the Gorgon development, which it expects will deliver better long-term earnings than the market currently anticipates.

Against a Morgan Stanley price target of $3.30, the FNArena database shows an average price target of $3.04, Mermaid receiving three Buy ratings compared to two Hold recommendations from those brokers covering the company.

IT service group SMS Management & Technology is viewed by Morgan Stanley as the best of breed player in the consulting and project delivery services sector, so deserving a premium relative to its peers.

SMS Management also offers leverage to an upturn in demand for IT services and has the ability to scale its business up and down to maximise profitability across the cycles. This supports Morgan Stanley's forecasts of 15% annual capitalised net profit growth through FY13, which underpins its $7.80 price target.

The FNArena database shows an average price target for SMS Management of $6.95, with three Buy ratings and one Hold recommendation.

Oakton is also in the IT sector but here Morgan Stanley sees annualised earnings growth of around 12%, with solid cash flows and an improving balance sheet likely to allow for growth in dividends as well.

What should hold Oakton back compared to SMS Management is recent contract cost overruns and ongoing Tenix litigation, meaning a turnaround in the business may take longer than expected. Along with its Equal-weight rating Morgan Stanley has a price target of $3.45, while the average target according to the FNArena database is $3.66. Overall Oakton is rated Buy and Hold three times each.

Retailer Super Cheap is expected to deliver double-digit earnings growth in coming years, Morgan Stanley seeing solid sales growth and efficiency gains as the major drivers. As well, Morgan Stanley sees the move into bike retailing as a likely value enhancing move, while upside is also on offer from market share gains in Auto Parts.

Against an average price target according to the FNArena database of $5.81, Morgan Stanley has a target of $6.75. The database shows Super Cheap is rated as Buy three times and Hold twice.

Discount retailer The Reject Shop has a number of growth options in Morgan Stanley's view, the ongoing store rollout program to be supported by improved efficiencies in sourcing and cost control.

With double-digit earnings growth expected, Morgan Stanley has set a target price of $19.00, while the average target according to the FNArena database is $17.03. The database shows three Buy ratings and two Holds.

Morgan Stanley's list of favourable emerging companies is somewhat different to others in the market, as JP Morgan's preference list is composed of Ausenco ((AAX)), Campbell Brothers ((CPB)), Norfolk Group ((NFK)), Retail Food Group ((RFG)), Salmat ((SLM)), TFS Corporation ((TFC)) and Tox Free Solutions ((TOX)).

Credit Suisse's top five emerging companies list also contains Campbell Brothers, along with Tower Australia ((TAL)), Pacific Brands ((PBG)), Virgin Blue ((VBA)) and PanAust ((PNA)).

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