COFFEE REPUBLIC - 2007 Liberated! It’s all about the brand !

Aim for a recovery,
15 December 2006

Finding a genuine recovery story is the value investor’s holy grail, and finding it before anybody else has recognised its recovery potential will result in the greatest value being extracted. As Warren Buffett, the ultimate value investor, once said: “Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well.”

There are certainly plenty of unloved companies out there – some justifiably so. However, there are a small number of others that have simply fallen by the wayside – due to past misdemeanours or trading problems – that are now ripe for a recovery due to a change in management or strategy.

Many of these are on the Alternative Investment Market (Aim). The junior market has had a fairly torrid time and smaller companies in general are now among the most unloved. What this means, though, is that Aim now contains several potential recovery stocks that you should consider tucking away for 2007.

What you should look for
Recovery investing is essentially ‘value investing-plus’ – in most cases, cash is king, so the company in question should have a solid balance sheet bolstered by a decent cash pile or easily realised assets. This gives the company an intrinsic value – what it would be worth if it shut down tomorrow and returned the value of its assets to shareholders.

This should be backed up by earnings growth, or the expectation of earnings growth, and the prospect of growing margins. In most recovery situations, the company will have short-term issues that will be easily resolved or already on the way to resolution. These short-term problems should not be mistaken for terminal decline. Internal problems can often be addressed through simple measures such as a change of management or the sale of an underperforming division. Competent management should be able to put the company back on track.

Underlying all this is the back-up clause that a recovery or value investor relies on – the fact that a fundamentally undervalued company with cash or assets on its balance sheet is always likely to attract predatory interest eventually. Such interest can come from industry rivals looking to pick up assets or customers on the cheap, from asset-strippers, or from private-equity players who think they can run the company in a more efficient manner. This is the worst-case scenario, but it should underpin the investment case.

One of the key tools for recovery investors is price-to-book value, which looks at the value per share of a company’s assets against its current share price, thereby helping you establish the value inherent in the company should it cease trading. But be aware that the net assets shown on a company balance sheet are an historical snapshot and may be materially different by the time research is carried out, especially if it is several months since the last published accounts. Net assets can also be artificially inflated by goodwill on a balance sheet relating to historical acquisitions, which may need to be written-down in future.

The best recovery investors also need one virtue more than anything else: patience. Companies do not recover overnight and an investor picking up an unloved stock should be prepared to hold it for at least 12 months, if not longer. What’s more, he or she should also be prepared to accept defeat and sell should the recovery not materialise – so take care not to become too attached.

Get it right, though, and rewards will come. The potential in recovery stocks was illustrated recently by the publication of the Hidden Gems report by RSM Robson Rhodes, which dug out the most cash-generative, but undervalued, companies in the UK over the past year. According to RSM, the 50 most cash-generative companies in the UK created £12bn in shareholder value over the past year, but remained underrated by the stock markets. Unfortunately, many of these companies have now moved beyond recovery-stock status, but some still qualify. In fact, the potential value in such companies was illustrated by the fact that six of the previous year’s top 50 Hidden Gems had been acquired in the subsequent 12 months.

Prime examples of the recovery stocks thrown up by our research in the past 12 months include Coffee Republic, which has benefited from a change in sentiment brought about by a change of management. Others include Renew Holdings, where a change of management and strategic focus has also brought about a strong recovery in trading and its share price, and Tanfield Group, where a company-transforming acquisition has also transformed its share price.

So we have trawled the lower reaches of the Aim and main market again, to find six stocks with recovery potential for 2007 and beyond. These stocks have different characteristics, which means each will have its own recovery timeline.



The rest of the article can be found on the link above.

Regards
Nectarios :-)