Morningstar backs this hat-trick of small caps for big growth
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Morningstar believes there are some real bargain stocks to be found on the ASX. It has just released its monthly ‘Best Stock Ideas’ report highlighting companies trading at discounts to its assessed fair values.
Three of them were small caps.
Stockhead spoke with analyst Adam Fleck about why Morningstar is backing these specific companies — Avita, Southern Cross Media, and G8 Education.
Avita has been one of the ASX’s best health success stories in recent years as it began commercialising its burns treatment Recell.
Morningstar believes more growth is to come, setting a target price of 95 cents – nearly double its current price of 49 cents.
“We initiated coverage on that company [Avita] that long ago and we immediately realised this is an interesting product they have in Recell,” Fleck told Stockhead.
“It seems like this should become the standard of care in the US – a big market, big opportunity for growth.
“The market seemed to be concerned about how long that might take or the regulatory environment they might have to navigate.
“We’re pretty confident and you can see that we think it’s worth double where it is right now. We think it’s a really interesting opportunity that the market is perhaps not focused on, or maybe doesn’t fully understand.
“We think the re-listing and re-domiciling of the company to the US may end up unlocking some of that value as they have a pretty deep understanding of pharmaceutical companies in the investor base in the US.”
The radio station owner has dropped from 87 cents to 23 cents in the last 12 months.
It had to undertake a $169 million capital raising to stay afloat during the crisis but Fleck believes it will be well positioned to flourish in better times.
He understands shareholder frustration at selling diluted equity at a discount, but expects the company’s fortunes to improve in line with the broader economy.
Morningstar thinks its fair value is at 38 cents.
“If a company has to go out and issue diluted equity and raise capital from shareholders at prices well below what we think the shares are worth it might be an opportunity to buy more of the company,” Fleck said.
“But it does crystallise some of the challenges in that you’re only getting a slither of what we think the shares will be worth in the long run.
“And that’s what we’ve seen happen with Southern Cross. We think this business has decent growth prospects.
“As consumer sentiment and business confidence returns and you see advertising start to turn up again that [growth] is our expectation.
“But to get from here to there, they needed more equity and that came at a pretty steep cost which is why you’ve seen the shares underperform recently. But we’ve adjusted for that in our fair value estimate and still see value there.”
The childcare provider received a particularly big endorsement from Morningstar. It tipping its fair value at $2 – nearly double its current share price.
Similar to Southern Cross, G8 copped a short term hit from COVID-19 because it forced many centres to close.
“There’s definitely been a short term hit to occupancy rates at childcare centres,” Fleck said.
“But longer term population growth [and] female workforce participation continues to rise, and I think [G8 is] probably a better managed business than you’ve seen in the past out of Australian childcare centres – like ABC Learning Centres for instance.”
Fleck said the extent of G8’s plunge, 70 per cent in a month, surprised him. However he was confident G8’s in long term opportunities.
“We remain pretty confident in the long run drivers of that business and importantly believe after the share issuance that they’re in a pretty good balance sheet position,” he said.
“We were pretty surprised they came out and did a share issue but it seems like they’re positioning their business for potential growth opportunities out of the current situation.
“It came at a diluted price but it does increase flexibility and long run growth options.”