Nuclear support services expert Redhall (RHL:AIM) is a good example of a company which trades significantly below analyst price targets. The reasons behind the depressed price are falling earnings and an unresolved court battle which has cast a shadow over restructuring benefits and traction with cross-selling efforts. Yet analysts are unanimously positive over the company's future.

The gap between how the market values a company versus analysts' forecasts is the core discussion in this week's issue of Shares. We look at several equity situations, provide guides on how to understand valuation models and explain what it would take for companies to re-rate and hit a price target.

In Redhall's case, the market's muted reaction yesterday to half-year results shows that investors are not yet prepared to take the plunge and consider the £15.2 million cap to be a bonafide recovery story. It needs to provide evidence of earnings recovery and resolve the legal issue relating to the termination of a contract with Vivergo.


RHL - Comparison Line Chart (Actual Values)

At 51p, Redhall trades considerably lower than broker price targets. FinnCap is looking for 80p, Charles Stanley eyes 110p and Arden has a 'longer-term' price target of 140p.

Interim results on 12 June showed a reduction in earnings on the previous six months, causing investors to worry about the recovery efforts. On a year-on-year basis, adjusted operating profit fell from £1.6 million to £1 million. Gross margins have fallen from 17% to 15%, no dividend was declared and net debt has risen from £10.6 million to £18.6 million over the six-month period because of working capital commitments.

A quick chat with the management yesterday reveals that cross-selling efforts could be key to earnings growth. This is securing manufacturing work for customers to whom it normally provides specialist services, and vice versa.

Unfortunately the weak earnings and subsequent downgrade to forecasts by analysts over-ruled any confidence in the management's outlook.

So when will value investors start to reappraise the stock? The shares, after all, have nearly halved in the past 12 months and trade on a low price to earnings (PE) multiple for its sector. Based on 2013 forecasts, the PE is 8.3, a reflection of historic disappointments and present earnings and balance sheet weakness. In contrast, peer group giant Babcock International (BAB) trades on a PE of 16.2 for its current financial year.

A potential catalyst for getting investors back on side will be conclusion of the Vivergo matter. The court hearing concluded seven months ago, so Redhall may get a definitive answer over the next few months.

Charles Stanley analyst Andy Smith reckons there's plenty of reasons to be bullish about the stock. It is worth noting that his employer is the house broker yet this analyst does know the sector very well and has made some good calls on other stocks. He says the decline in first-half profitability was largely down to the timing of new work in the nuclear and manufacturing divisions rather than a lack of volume. The group's order book is at record levels, having increased from £119 million in September 2012 to £152 million.

Smith forecasts that Redhall will this year report a 15.8% rise in pre-tax profit to £2.2 million. This jumps to £3.9 million in 2014 and £5.9 million in 2015 which certainly implies better times for the stock ahead.

None of the analysts have forecast a resumption of the dividend. The company hopes it will eventually revive the shareholder reward but wouldn't put a definitive time on when this will happen. It merely says the dividend will depend on strong profit, cash and resolution of the Vivergo issue.

There's clearly plenty of reasons to be either bearish or bullish for the stock in its present situation. But one thing's certain: you'd be foolish to not keep your eye on events given those strong earnings forecasts.

Issue Date: 14 Jun 2013