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7 small caps for your sell list

Glenn Freeman  |  05 Nov 2019Text size  Decrease  Increase  |  
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Buy now pay later player Flexigroup joins CSR (ASX: CSR), Mortgage Choice (ASX: MOC) and ALE Property (ASX: LEP) in this group of small cap stocks trading at more than Morningstar thinks they're worth.

We regularly bring you insights on companies Morningstar considers to be undervalued versus our analysts' fair value estimates. But this week we've screened our company coverage list for small cap stocks that are trading in one- or two-star territory.

Although some of these companies may have good growth stories, their stocks are too expensive today for our taste. Seven names made the cut.


small caps

Mortgage Choice (ASX: MOC)

Price/fair value ratio: 1.39
Uncertainty: Very High
Economic Moat: None

The outlook for Mortgage Choice has improved following the federal election in May 2019, with the removal of some political and structural headwinds.

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In our view, Labor’s policy platform included a wide range of direct and indirect negatives for the property market and mortgage broker sector. But industry headwinds remain and the outlook for Mortgage Choice is challenging.

Primary challenges come from the steep industry-wide decline in home loan approvals, which dipped 15 per cent in the 12 months to June 2019, and the firm's 13 per cent fall in franchisee numbers this year. This has dampened significantly in the wake of the banking royal commission.

We believe fiscal 2019 is likely to be the low point in earnings, but we do not expect a strong recovery.

Morningstar believes the stock is worth $1.10, versus a price of $1.40 at the market open on Monday.
(Nathan Zaia)

Super Retail Group (ASX: SUL)

Price/fair value ratio: 1.22
Uncertainty: Medium
Economic Moat: None

Ranking second in terms of its price-to-fair value ratio, Super Retail's core business is automotive retailer Super Cheap Auto, along with Rebel Sport Group and camping equipment distributor BCF. Though it doesn't earn an economic moat, the group is the market leader across all three categories.

Recent sales growth in the October quarter came at the expense of profit margins, as prices were cut to drive the top line, in line with our expectations.

We maintained our $7.70 fair value estimate, and shares remain overvalued. We surmise the market is still too optimistic on the company’s long-term earnings growth outlook, whereas we expect competition to keep margin expansion largely in check.

We expect competition to be robust in auto parts and outdoor retailing, but we anticipate sporting goods to be the most hotly contested segment.

Amazon Australia poses perhaps the greatest threat to Rebel which transacted 9 per cent of total sales on its online channel in fiscal 2019.

With an opening price of $9.72 on Monday, Super Retail stock trades at a 22 per cent premium to our $7.70 fair value estimate.
(Johannes Faul)

Flexigroup (ASX: FXL)

Price/fair value ratio: 1.20
Uncertainty: High
Economic Moat: None

As it embarks upon a strategy to simplify the business and expand its target market, Flexigroup plans to reduce its focus to four brands, from approximately 20 previously. Renewed focus brands include buy now pay later products humm and Bundll, which it plans to launch later this year.

Bundll transactions will be processed via the Mastercard network, with one main difference between Bundll and humm being Bundll will be accepted immediately in far more merchants – anywhere Mastercard is used.

Flexigroup’s new BNPL products is a further example of what we believe is the beginning of intensifying competition in the category.

Further, we expect some consumer advocates may fear delaying repayments in the manner offered by Bundll may lead some more vulnerable consumers into financial hardship.
With a share price of $1.92 at the open on Monday, Flexigroup is currently trading 20 per cent above what we believe it is worth.
(Chanaka Gunasekera)

CSR Limited (ASX: CSR)

Price/fair value ratio: 1.20
Uncertainty: High
Economic Moat: None

One of Australia's leading building products companies, CSR has undergone a significant transformation, with the sale of the sugar business in 2010 creating a more focused building products group.

Capacity reductions, industry consolidation, and buoyant construction markets have underpinned earnings growth, while high aluminium prices also have been a strong tailwind.
This has enabled CSR to earn good but unsustainable returns on invested capital in recent years.

On the back of longer-term challenges for CSR's Tomago aluminium smelter as high electricity prices persist, our long-term outlook unchanged and our fair value estimate of $3.60 a share remains in place.

CSR’s shares screen as expensive, opening Monday's trading at $4.40, an almost 20 per cent premium to the $3.60 we believe the company is worth.
(Grant Slade)

Village Roadshow (ASX: VRL)

Price/fair value ratio: 1.18
Uncertainty: High
Economic Moat: None

A majority of Village Roadshow's earnings come from its cinema exhibition division, which enjoys solid competitive advantages, albeit not strong enough to earn an economic moat.

The strong market position of the theme parks division must be viewed against the backdrop of a tough industry characterised by intense competition and proliferating leisure alternatives for consumers.

Similarly, the film distribution business depends heavily on the popularity of movies it handles and must also deal with structural pressures in an increasingly direct-to-consumer digital streaming era.

We recently lifted our fair value estimate for Village Roadshow by 8 per cent to $2.70 a share.

But at Monday's opening price of $3.21, it currently trades at a premium of almost 19 per cent to what Morningstar believes it is worth.
(Brian Han)

Credit Corp Group (ASX: CCP)

Price/fair value ratio: 1.18
Uncertainty: Medium
Economic Moat: None

Credit Corp is a consumer credit provider, which offers purchased debt ledgers in the US and issues loans to Australian consumers with an impaired credit history.

The company earned its first profit in the U.S. PDL business in fiscal 2018, with profits accelerating in fiscal 2019. It also continues to attract customers to its personal loan business.

Although the firm's consumer finance business and core activity of collecting PDLs means it faces regulatory risks, it's exhibited a strong compliance record.

It's also poised to take advantage of disruptions in the Australian PDL market, particularly after acquiring Baycorp – an established debt purchasing and debt collection operator in Australia and New Zealand.

Trading at $31.90 at Monday's market open, Credit Corp's share price is an 18 per cent premium to Morningstar's $26.50 fair value estimate.

(Chanaka Gunasekera)

ALE Property Group (ASX: LEP)

Price/fair value ratio: 1.16
Uncertainty: Medium
Economic Moat: None

The least overvalued stock on this list, ALE Property Group operates an extensive portfolio of freehold pub properties across Australia's major capital cities and metropolitan areas.

The small-cap Australian REIT has relatively predictable earnings underpinned by long leases to a strong tenant. But its fiscal 2019 earnings were slightly below Morningstar's expectations.

Distributions are propped up with debt, with increased distributions used to manage gearing. Gearing levels will be reviewed after completion of the ongoing 2018 rent reviews.

There’s some uncertainty about the future gearing and distribution policy, given that the long-term CEO and managing director, Andrew Wilkinson, announced in August he is leaving. The new CEO could take a more conservative approach on gearing, which could in turn effect future distribution.

The REIT's share price opened at $5.35 on Monday morning, 16 per cent higher than the $4.60 we believe it is worth.
(Chanaka Gunasekera)

is senior editor for Morningstar Australia

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