6 Growth Stocks To Watch Before They Rise

by: FAF Research

I like to focus on smaller, lesser known names that have attracted institutional interest in the past quarters. While these stocks have nothing in common (unrelated industries and business models), I selected them because they show interesting potential growth and trade at reasonable valuations. I use a screen that tracks recent institutional purchases and select stocks that call my attention from that list. The stocks should be not widely followed by Wall Street and trade at attractive valuations in relation to historical multiples. I think it is essential to focus on companies that offer potential earnings power, clear catalysts and are not widely followed by the media. Let's focus on them:

Your alarm sounds: a great investment entered to your house!

ADT Corporation (NYSE:ADT) provides electronic security, interactive home and business automation, and related monitoring services primarily in the United States and Canada.

ADT has several positives in its overall business model: recurring service revenue and steady-state net operating cash flow. In addition, there is a huge potential upside in earnings from accelerated adoption of the "Pulse" interactive offering, which is an innovative service to automate ADT home system offerings. I expect ADT to maintain its target leverage of 2.0x, which could support further stock buybacks or acquisitions.

In a recent report, Stifel Nicolaus explained that ADT has outgrown the alarm monitoring industry over the last four years, and its growth rate should improve over the next several years as the trend of interactive and home automation services gains more traction. ADT is the leader in the alarm industry and it can increase its customer base from its recently launched ¨Pulse¨offering. Stiefel believes that newer services have the potential to "push out" the attrition curve and improve the IRR of accounts by 400-500 basis points, improving the economics of the overall business over time.

The last quarterly earnings release reflected a continued solid growth in recurring revenue, which is a key element in ADT's business model, along with further improvement in take rates for ADT Pulse. Management explained that one out of every three new customers in the residential direct channel is a Pulse subscriber and their efforts to increase penetration of Pulse in the small business and dealer channels are showing great success, with very strong growth in each of those channels.

The company is also buying back shares at an increased rate. Management recently announced that it has entered into an accelerated share repurchase agreement with Credit Suisse International, under which it will repurchase ~$600 million of its common stock.

ADT has been growing by acquisitions and that could become a challenge in the future given the risk of overpayment for growth. For example, ADT acquired the second largest player, Broadview Security in 2010, for $2 billion or about 3x Broadview's sales at that time (source: What's ADT Worth?).

Fruits in your portfolio

Dole Food (NYSE:DOLE) is a leader in the fruit processing business. Basically, shares are cheap considering a forward P/E of just 10x compared to SP&500 average multiple of 15x. I think that after the recent sell-off, this stock appears cheap considering its valuable real estate assets, and a major deal looming (ITOCHU Corporation). If the coming deal closes, the company will have a much stronger balance sheet to buy back shares or initiate a dividend. I think that shares have found a floor in the $10 range and may have material upside if these mentioned catalysts materializes.

After the ITOCHU deal closes, the ¨New Dole¨ will continue as an international commodity produce company with a smaller footprint, retaining its entire North American fresh vegetables business as well as its fresh fruit businesses in North America, Latin America, Europe and Africa, which together generated $4.2 billion in revenues in fiscal 2012, and Adjusted EBITDA from continuing operations of $146 million. In other words, a more flexible company, focused on its core businesses and strengths. This deal appears to be an important catalyst because it will give the company a significant amount of cash, which could be used to the benefit of shareholders.

Dole could face challenges if the macro scenario deteriorates as this company is exposed to the end consumer and its disposable income levels. While I think that Dole is not immune to a potential macro shock, management is working on several measures (cost reductions and growth strategies) to reduce the volatility that Dole business experience from the economic environment.

The best Chinese small cap?

SouFun Holdings (NYSE:SFUN) is one of the best Chinese growth plays and it is not widely followed by the media or Wall Street.

Let's review some outstanding key metrics from this company:

  • Operating margin of 40%

  • Net margin of 29%

  • ROE of 110%

  • No debt

  • ROA of 17%

SouFun Holdings operates a real estate Internet portal in China and was founded in 1999. The company provides advertisements for real estate developers, real estate agencies and home furnishing/improvement vendors. Users of the website also include property owners, property managers and lenders.

In the recent report, SouFun Holdings beats on revenues and its management projected FY13 EPS and revenue estimates above consensus averages. Gross margin was 82.8% for the fourth quarter of 2012, a slight decrease from 85.1% for the corresponding period in 2011 but still very high. The slight decrease was primarily due to the expanded implementation of the value-added tax system during 2012.

SouFun management has a strong focus on expanding existing business and pursuing constant innovation that has allowed SouFun to deliver solid results quarter after quarter. I believe such investments are critical to ensure SouFun's long-term sustainable expansion and will create significant value for our shareholders in the long run.

I like the fact that management sounded optimistic in the last earnings report, raising SouFun total revenue guidance for 2013, from between $516.0 million and $527.0 million to between $527.0 million and $538.0 million, or from a year-over-year increase of between 20.0% and 22.5% to between 22.5% and 25.0%, despite uncertainties in China's property market. This forecast reflects SouFun's strong fundamental metrics.

A very interesting Chinese pick

I also like 51Jobs (NASDAQ:JOBS), the ¨Monster.com¨of China. Similar to SFUN, this company has outstanding metrics:

  • Operating margin of 34%

  • Net Margin of 30%

  • ROA of 15%

  • EBITDA Growth of 39%

  • Average 3-year EPS growth of 50%

  • No debt

51job keeps producing improving quarterly results. The provider of online workforce recruiting, corporate outsourcing, and other human resources services posted better-than-expected results in the past quarter. JOBS' earnings of $0.66 a share or $0.74 a share on an adjusted basis clocked in well ahead of the $0.61 a share that analysts were forecasting.

Considering a high economic growth and huge population in China, the recruitable labor market is growing and has driven growth in the 51jobs revenue and net income despite the global economic downturn. According to WikiInvest, the alliance with Recruit can help 51job explore further opportunities within the human resources industry and potentially new information services businesses in China because Recruit is a leading human resource services provider in Japan.

I am bullish on Chinese economic prospects, which will be beneficial for workforce recruiting companies. The company trades at a low P/E (22x) compared with its growth, which translates into a PEG of just 0.6x. Remember that is very strange to find strong companies trading at a PEG ratio below 0.7x.

A lesser known, but strong property REIT

I think one of the better plays in U.S. REITS is Ryman Hospitality (NYSE:RHP), a REIT that pays a 4% yield.

Ryman Hospitality Properties assets include four meetings-focused resorts totaling 7,795 rooms that are managed by Marriott International under the Gaylord Hotels brand.

Ryman also owns and operates a number of media and entertainment assets including the Grand Ole Opry (opry.com), the legendary weekly showcase of country music's finest performers for nearly 90 years; the Ryman Auditorium, the storied former home of the Grand Ole Opry located in downtown Nashville; and WSM-AM, the Opry's radio home and the only clear-channel station in the U.S. broadcasting music.

Ryman has a shareholder oriented management team that announced a special dividend at the end of 2012. In addition, the company pays a quarterly cash dividend in amount to at least 50% of AFFO or 100% of taxable income, whatever is larger.

RHP management also plans to buy back shares for up to $100 million using both cash on hand and borrowings under its revolving credit line.

A medical pick to consider

HCA (NYSE:HCA) is a very interesting pick in the medical sector.

In a recent report, Cantor Fitzgerald increased the target for HCA to $45 from $35 to reflect the company's strong position in the market and its improved utilization. Over the past two years, HCA's utilization statistics have been consistently among the best in the industry, and in 4Q 2012 those metrics were substantially better than those of its peers.

The stock is trading at just 10x earnings, which is quite low for a leader in a defensive industry. In fact, this company became a role model for its peers and trades at a high return on capital (ROC) and earnings yield (EY), two metrics that a value investor looks for when investing in a stock.

HCA challenges could come when it has to refinance its debt: the company has a high percentage of debt over its total assets. This could be a problem if rates increase in the coming years and debt refinancing becomes unattractive. While the business is solid, this is a potential threat to keep an eye on.

Sources: Briefing Premium Subscription, Seeking Alpha, company IR website, Yahoo Finance, Motley Fool

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in ADT, DOLE, HCA over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.