Small-cap stocks with market capitalizations above $1-billion may realize greater visibility from financial analysts, as well as institutional and retail investors.
For that reason, shown in the accompanying table are several securities from the S&P/TSX composite index and the TSX small-cap index that are trading on the cusp of this level – either returning to the $1-billion mark from earlier price weakness or rising to this level for the first time.
Also provided are the consensus ratings as well as the average one-year price targets for each security, according to Bloomberg, in order to provide investors with greater information that may be helpful.
One such stock that is resuming its uptrend and appears on this list is dividend-payer Morneau Shepell.
I recommended this stock last November, suggesting investors put it on their radar screens but cautioned investors to wait until after the company reported its third-quarter results before accumulating shares, believing there could be further price weakness.
The stock price continued to drift lower after reporting its financial results and this weakness represented a buying opportunity. Since then, the stock price has rebounded, delivering investors with a solid double-digit total return. Given its share price recovery, the company is revisited below.
The company
Toronto-based Morneau Shepell is a human-resources consulting and technology provider offering services such as employee assistance programs, and benefits and retirement administration.
- Solid fundamentals. First, let’s briefly recap a few of the company’s attractive defensive attributes. The company has very high recurring revenue, 97 per cent in 2015, providing the company with stable cash flow. Morneau Shepell’s customer base includes long-term relationships with blue chip companies from diversified industries. The company’s historical revenue growth rate is attractive. Furthermore, its monthly dividend appears sustainable.
- Strengthened balance sheet. Last month, the company completed a bought deal financing. The proceeds can be deployed to fund the company’s growth.
- Contract wins. In the first quarter, management signed a large contract with the state of Illinois, which is expected to make that Midwestern state one of the company’s top 10 clients. Service is expected to begin in the fourth quarter.
- Potential positive revisions. The consensus revenue forecasts have upside potential, particularly if the company uses part of the proceeds from the recent financing to make an acquisition. The company has a history of growing organically and also through acquisitions, and is committed to steadily expanding in the United States.
Dividend policy
The company pays shareholders a monthly dividend of 6.5 cents a share, equating to 78 cents a year, or an annual yield of just more than 4 per cent. The dividend has been maintained at this level since 2011. Last quarter, the payout ratio was 59.8 per cent of its normalized free cash flow.
Valuation
The share price appears expensive, trading at an enterprise value-to-EBITDA multiple of approximately 10.5 times the 2017 consensus estimate, approaching its peak multiple over the past three years. (EBITDA represents earnings before interest, taxes, depreciation and amortization.)
Analysts' recommendations
According to Bloomberg, the one-year average target price is $19.10, which is based on four buy recommendations and one hold recommendation. One-year price targets are concentrated with the four buys pegged between $19 and $19.50.
The consensus revenue estimate is $608-million in 2016, rising 7 per cent to $653-million in 2017. The Street's earnings before EBITDA is forecast at $115-million in 2016, climbing more than 6 per cent to $122-million in 2017. This is consistent with management's guidance, targeting organic growth of between 6 per cent and 8 per cent.
Chart watch
The stock price may drift back down to the $18 level as it digests its recent gains. There is strong technical support between $17 and $18 with the 50-day moving average in the middle of this range (at $17.55). Failing that, there is support at $16, close to its 200-day moving average (at $16.06).
The bottom line
I believe Morneau Shepell is a solid core holding for investors seeking a defensive stock that provides reliable income. While the stock's valuation may have gotten ahead of itself in the near-term, I wouldn't recommend selling the stock on its recent strength; instead I would recommend accumulating shares at times when there is price weakness.
As always, I strongly encourage readers to consult a financial adviser, and to do their own proper due diligence before taking any investment action.
Jennifer Dowty, CFA, Globe Investor's in-house equities analyst, writes exclusively for our subscribers at Inside the Market.