Barlo and Kingspan steeled for profits

Over the past year many Irish mid- and small-capitalisation stocks have enjoyed a substantial re-rating in their share prices from what were historically quite depressed levels.

The share prices of Irish small-capitalisation companies had been under downward pressure due to two key factors. Firstly, investors worldwide were shunning smaller "old economy" stocks in favour of the larger global companies. Secondly, post the introduction of the euro, Irish institutional investors became sellers of Irish shares as they sought to diversify their portfolios into the euro zone.

Over the past six to 12 months investor sentiment has altered direction radically and now "old economy" stocks are firmly back in favour. Furthermore, the Irish institutions would seem to have completed their diversification programme.

However, only those companies that can demonstrate an ability to grow profits have been rewarded with higher share prices. Also, companies that announce any indication of deterioration in trading conditions find that the market rapidly marks down their share prices.

Barlo and Kingspan are examples of two small-capitalisation companies whose share prices have risen over the past 12 months. Kingspan is up 43 per cent while Barlo is now up a more modest 10 per cent. However, the share prices of both Barlo and Kingspan are well below their respective 2001 prices.

Kingspan suffered a setback some months ago as fears mounted that its US operations would suffer if the US was to slide into recession. Recently the shares have recovered, rising by 12 per cent in the past month alone, as the market took a more sanguine view of Kingspan's prospects. Barlo recently announced record profits, but the accompanying statement warned of tough trading conditions this year in its key radiator division.

Investors seemed to ignore the good results and instead focused on the negative trading statement, marking down the shares by over 10 per cent on the day. Subsequently, the share price has recovered somewhat but it is still down more than 2 per cent since the beginning of the year.

Recent developments in the steel market could provide some good news for both companies. The US government has taken steps to reduce steel imports and there are fears that this will create an oversupply of steel in Europe with consequent downward pressure on steel prices. Steel is a major input for booking Kingspan and Barlo and represents a substantial proportion of total input costs for both companies. Therefore, lower steel costs should improve the profitability of both companies over the next 12 to 18 months.

Irrespective of the likely favourable impact from lower steel costs, the share prices of both companies still seem somewhat undervalued compared with the overall market and compared with similar publicly quoted UK companies (see table). Barlo is trading on a lowly price/earnings ratio (PER) of 6.5 while Kingspan is on a somewhat higher multiple of 9.5.

This compares with an average PER for the non-financial companies in the market of approximately 17.5. Given the strong track record of the managements of both of these companies, a higher stock market rating seems warranted in both cases.