Page 1 of 3

Christine St Anne is Morningstar's online editor.

Reporting season will soon kick off and there is no doubt analysts and investors will be scrutinising the earning announcements of Australian companies over the next few weeks.

Preliminary data suggests corporate balance sheets in Australia are relatively healthy. According to Morningstar data, the average net-to-debt equity ratio of ASX-listed companies (excluding banks and major banks) has fallen since 2010.

At the same time, private equity firms are cashed up. Already, PaperlinX (PPX) and Pacific Brands (PBG) are within the sights of these firms.

In a recent report from Morningstar, the firm's head of industries research Peter Rae notes the combination of healthy balance sheets, poor organic growth prospects and cheap equity prices could spur companies to achieve growth via acquisition.

So, while corporate growth may remain subdued, heightened activity via mergers and acquisitions (M&A) could be a feature of the corporate landscape in 2012.

Platypus Asset Management chief investment officer Don Williams also believes there will be increased M&A in 2012, particularly as company boards are more confident in the revenue outlook for 2012.

"There was view that in 2010 it was going to be a big year for M&A because of the strength of balance sheets and cheaper assets. But that didn't happen. Why? Because boards did not have the confidence that the revenue would be there to justify the risk in buying something," Williams says.

"A year later, uncertainty in world markets increased, and with Europe unwinding it really knocked M&A activity on the head."

Williams says this year will be different as it is less likely that an extreme macro event will happen.

While the International Monetary Fund (IMF) issued a warning about growth prospects for the early part of the year, Williams notes the IMF also predicted growth would accelerate in the second quarter of the year.

The relatively benign economic environment should not not spook too many companies off the acquisition trail.

The smalls

The Morningstar report identified a number of small-cap stocks as possible targets.

Small companies are most vulnerable to weak business conditions. A further round of earnings downgrades are predicted in the non-resources sector. The private equity bids for Spotless (SPT) and PaperlinX has highlighted that some of these companies may in fact go private.