It was another difficult year for the market in 2007, with the Jamaica Stock Exchange (JSE) main index advancing nominally by 7.2% but in real terms it actually declined by more than 7%. For 2008 we expect to see more of the same, nominal growth and real decline.

2007 Review

We have changed the method of evaluating the market’s performance from year-end valuation to 52 weeks high, as with the latter we can set target prices and avoid market vagaries at the end of December when the temptation might be greatest to heighten portfolio valuations.

Table 1 below shows 2007 stock performance using both methods.

The first thing to notice is that the five best performers gained over 100% returns and four of them maintained their positions relative to each other under both methods. This suggests either that they all ran up towards the end of the year or some advanced earlier and held the gains throughout. Supreme Ventures was the only stock to have made its gain of over 100% in the first half of the year, the others achieved that feat in the last two months of the year. Gleaner, Lascelles and CMP moved up in price on buy-out offers and or rumors of such, and Mobay Ice on improved earnings. 

Another observation with the chosen methodology is that only six stocks needed to have suffered losses compared to 23 losers based on year-end close. It therefore acts as an early indicator to investors to minimize losses and maximize gains.

Again, using the new method our pick for 2007 yielded the following results:

Salada Foods Jamaica             75.0%

First Caribbean Jamaica            50.4%

Pegasus                                   (2.9)%

2008 Picks

For the third consecutive year we have selected the same stocks to which we have added back Montego Freeport that was dropped in 2007.

 -Salada Foods Jamaica

Despite its spectacular price appreciation in 2006, this stock is still undervalued. The acquisition of majority stake in 2007 by Donovan Lewis helped to propel the stock price to its 52 week high of $70 and closer to our target price of $88. The sale of Caribbean Investment Holdings 18.3% stake in the company to a yet undetermined buyer on January 4, 2008 could see further accumulation by large players. Since its reorganization in FY 2005 the company has clearly turned around, revenue has grown by an average of 12% in the last two years and net profit many times faster. The balance sheet is very strong with little debt, the debt to equity ratio is 8.7%. For FY 2007 the return on equity was 24.9% and return on asset of 20.8%. It has free cash flow of $58.2m and represents 17% of revenue compared to the 10% rule of thumb. At the current share price of $45.30 the price earnings ratio (P/E) on historical earning is 6.9 and on forward earning 6.6. The P/E is below its average growth rate and is therefore a buy with the potential return of 94.3%. Our target price is based on a P/E of 12 and earnings per share of $7.34 for FY 2008. The declaration of a dividend could further boost the stock price to over $100 given that in the last FY the company earned $1.41 per share in finance income, has excess capacity and shareholders equity is 60% cash, it can easily pay $1.00 per share.

 -First Caribbean Jamaica

The benefit of moving ahead to aggressively grow its loan portfolio while the competition was still fixed on government paper, allowed the bank to chalk up a 31% increase for FY 2007 on top of the 74.9% it achieved the previous year. Net income is up 20.6% but the share price has floundered and currently trades at $27.00. The company has the second lowest P/E among banks and a depressingly low stock price premium of 28% compared to the average 170.5%. Valuing the stock at the average premium would set the target price at $46.04 with P/E of 15 on projected earnings.

Congratulations are in order to the “Brady Bunch”.

 -Pegasus

This is a real estate investment, so as long as the company manages to at least break-even on its operation, investors need not worry. Unbelievably, over the last four years the stock price has grown in total equally in line with the growth of the capital reserves. The net asset value per share at FY 2007 was $23.78 and the current stock price is $15, therefore the stock is trading at a 37% discount. Worse, the land at $7.51 per share is not the only thing not factored into the price otherwise it would be trading at $16.27. My information is that land in New Kingston are valued at US$2.5m per acre and would therefore add $23.31 to set the target price at $39.58, making the true stock price discount 62%. 

 - Montego Freeport

Another real estate play but with a bad habit! The main sources of income for the company are from rental and interest on investment. The rental income is rarely sufficient to cover its administrative expenses yet on the last two occasions that substantial investment properties were sold the company distributed not only all of the proceeds but 90% of the cash at the end of the preceding accounting year. Bear in mind that in periods where there are no disposals cash is mainly generated from interest earned. Montego Freeport should therefore be traded on value and not earnings. As at Q2’08 the net asset per share was $2.92 and the stock last traded at $1.70, a 42% price discount. Our target price is $3.00 but most importantly sell the stock between the declaration of dividend/capital distribution and the x/d and or x/cd dates. The price will tank post the ex-dates way more than the distribution and smart investors will reload for the next round. Always keep a keen eye on the value of the investment properties because when it’s done, its over.     

Source: Jamaica Stock Exchange