Five Alternative Stocks Worth Your Attention

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By Rudi Filapek-Vandyck, Editor FNArena

It never ceases to amaze me how the financial services industry will always use a short memory and a blunt approach to available data in order to make a case that Australian equities are still attractively priced, even after shares have rallied more than 20%.

The latest of such observations comes at the expense of CommSec which has been touting its latest piece of "research" with the conclusion that the long term average Price-Earnings ratio for the Australian share market is 15.6 which is about where the current PE is at the moment. The obvious suggestion here is this market can go a lot higher still; we're still only at the long term average!

I say B*ll*cks. Before the late 2007 meltdown, the widely repeated mantra was that Australian equities had an average PE of between 14 and 14.6, depending on whose calculations we could rely upon. Now, after five years of bear market and generally depressed PEs, the long term average has all of a sudden jumped up to 15.6. How's that possible?

Try incorporating the above normal Dot Com years of the late nineties. Anyway, it is not abnormal for PEs to rise to above long term averages in the first year after a recession or a bear market depression, and that's what we are experiencing right now, but assuming those PEs correct at some point after everyone who wants to own a dividend stock has bought one, and what are we going to talk about then? How PEs remain below the long term average? Thus the share market is always going to look undervalued in the years ahead?

As the relentless shift from money elsewhere into solid dividend paying stocks in the Australian share market continues, I thought it might be worthwhile to share five alternative stocks that have caught my attention during the running reporting season. For obvious reasons, I think these stocks deserve your attention too.

First up is Mayne Pharma ((MYX)). Older investors will remember the conglomerate Mayne Nickless, once upon a time a proud member of many an investor's long term portfolio. Another name from a long ago past is Faulding. Both legacies, or at least what is left of them, are combined in today's Mayne Pharma, which in itself has gone through a few name changes. It wasn't that long ago when the listed company was known as Halcygen Pharmaceuticals Ltd. In November 2011 it renamed itself Mayne Pharma, including a new ASX code. Investors will also recognise Roger Corbett (ex-Woolworths) who's the current chairman of the group.

Mayne Pharma is a so-called specialty pharmaceuticals company which essentially means the company develops and manufactures its own drugs and tries to sell them the world around. Think aspirin and a whole suite of other oral medicines. According to market whispers, the company has landed on the radar of several large funds managers in Australia and if that's correct it's more than likely linked to the recent acquisition of US headquartered Metrics Inc, also developer and manufacturer of niche generic pharmaceuticals. The deal has been described as "transformational" both by the company itself as by experts following the company.

No coincidence thus, Credit Suisse recently initiated coverage on the company with a twelve month price target of $0.45 (last price: $0.385) and a positive recommendation. Assuming management knows how to leverage off the new possibilities post the acquisition of Metrics, analysts at CS agree this company should be looking forward to several years of strong growth. Mayne Pharma recently announced the acquisition of Kapanol and related assets in Australia from GlaxoSmithKline (GSK) which necessitated a capital raising. Probably safe to assume there's no holding back the growth ambitions of current management.

As this latest share placement is fully underwritten by both Credit Suisse and UBS, I assume it shouldn't be too long before the latter will release its own initiation of coverage report. Given the strong growth projections in the Credit Suisse report (39-59% in FY14 and FY15) that'll add simply another positive recommendation in further support of growing interest for the shares, I reckon.

The company is not expected to start paying a dividend before FY15. On current estimates, the PE for FY13 looks a bit high (circa 26) but that'll come down quickly once those growth projections materialise. By 2015 the current PE should have fallen to 12. That seems like a bargain for a company with such a strong growth profile. This probably explains why the re-found interest from funds managers.

There is and always has been a latent interest for IT services stocks in Australia, but unfortunately there are no solid household names available on the local share market. Most companies are either recruitment companies or suppliers of IT solutions and support with a large dependency on regional and national government contracts. Not a good place to be when the promised budget surplus looks farther away than ever and with election day approaching. The current reporting season is showing negative growth for most companies in the sector and cautious guidances seem but appropriate.

Technology One ((TNE)) has developed itself into the stand-out benchmark in the local sector, with steady growth reported year after year after year and with promises of more of the same in the years ahead. The problem is, investors have now caught up with this growth story and the recent rally has pushed up the share price to a PE above 20. In all honesty, that seems a bit much for this company even as it has become the "primus inter pares" for the local IT sector.

There's an alternative, however, and it's called UXC ((UXC)). The company is, alas, not as widely covered as Technology One and that's a shame. Not one of the major stockbrokers in the FNArena database covers UXC, but the analyst at Moelis who does cover the stock is pretty upbeat. In addition, investors scrolling through the UXC website will find a lot they will like such as management's focus on a "strong balance sheet" and statements such as "we are builders for the long-term". Luckily, for investors, UXC is being covered by six smaller stockbrokers and the list can be found on the company's website.

UXC too has a bit of history to tell. The current Telecommunications Solutions division is what ultimately survived from Dot Com bust Davnet in Australia. The company's strategy is to build leading positions in profitable market niches, but that strategy temporarily came unstuck in 2010 when a perceived early mover advantage in the market for Renewable Energy Certificates turned into a dud. The company was forced to restructure, effectively selling off unprofitable assets and present a loss to shareholders that financial year.

Right now, optimism is back and double-digit growth should remain on the horizon. The stock still offers some 5% (fully franked) in dividends. This year's PE sits around 15, which is a helluvalot cheaper than the earlier mentioned Technology One. Higher dividends too.

Most investors' interest in telecommunication stocks starts and stops with Telstra ((TLS)) which is not that unexpected given the former government monopolist represents around 85% of all profits made in the Australian telecom services sector. Carried by a solid, admirable dividend yield, Telstra shares have proved among the outperformers in the Australian share market these past two years. In Telstra's slipstream are operating a few other outperformers in the local share market: TPG Internet ((TPM)) and iiNet ((IIN)) have performed pretty well for loyal shareholders and both have received a lot of attention in return. Lesser known is Perth-based Amcom Telecommunications ((AMM)) whose share price performance since 2009 falls in line with the two better known peers.

Visitors to Perth will have no problem in remembering the company's name as it owns one of the highest towers in the Western Australia's capital. Amcom specialises in, and thrives from, selling high speed fibre services while increasingly popular cloud services offer a healthy bonus on top. This is a company that is growing at 20% per year and it doesn't look like that's going to stop anytime soon. The only problem I can see in the short term is that the strong rally in the share price has now pushed up the PE to near 20 while the implied dividend yield has now sunk to 3.5%.

To illustrate the strong growth that has been achieved by Amcom Telecom over the past years, and the strong share price performance that went along with it, FNArena's Stock Analysis tells me today that shares bought three years ago now yield a fully franked 16.95% on the original purchase price. Harry Hindsight can be such a pain in the buttocks!

Another company that would not have received the attention of many investors just yet is Royal Wolf ((RWH)), specialised in containers – literally for all purposes possible! The company's website offers the option to download a catalogue for all kinds of containers. Most of the containers are being used for storage, but Royal Wolf is marketing its product for transport and housing as well. Only 15% of the company's annual revenues comes from the resources sector, with Building and Construction representing the largest revenue contributor (18%). This is one of the reasons why analysts are anticipating beautiful things from this company in the years ahead: once activity in the domestic construction sector starts improving…

Royal Wolf only listed on the stock exchange in May 2011 (to raise capital for growth) but its share price has gone ballistic since. Because of this year's strong growth profile, the PE is still only at 15 while implied dividend yield is 3.2%. The main no-no I could spot was the fact that daily trading volumes are still pretty benign, which means large investments cannot as yet be directed towards this opportunity. Maybe, as general awareness grows, investor appetite (and trading volumes) might follow?

Investors are by now aware the local market for automobiles can provide some excellent opportunities with ARB Corp ((ARP)) and Super Retail ((SUL)) amongst the best performing shares in the market in recent years. One other company that every now and then deserves investors' attention is Automotive Holdings Group ((AHE)) which sells and services vehicles, both to the retail market and to the corporate sector. Automotive Holdings is currently experiencing a growth spurt and even post the recent rally the implied dividend yield is still at 5% and the PE at around 14.

Analysts at stockbrokers simply loved the recent results release and a few of them have started speculating about the potential for a corporate take-over.

Note that all five companies mentioned reported a strong financial performance this month.

(This story was originally written on Monday, 25th February 2013. It was published on that day in the form of an email to paying subscribers.)

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(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. All views are mine and not by association FNArena's – see disclaimer on the website)

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Rudi On Tour in 2013

– I will visit Perth in March for two presentations both on Tuesday March 5: ASA first at noon and AIA later in the evening (7pm)

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