Pacific Brands Limited surges on profit upgrade but is it too late to buy?

Management will beat its profit guidance for the year thanks to better-than-expected trading conditions in the second half of 2014-15 and cost controls. There's more upside and the stock could come under the takeover spotlight.

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Intimate apparel and linen maker Pacific Brands Limited (ASX: PBG) may have turned a corner with the embattled company enjoying its best one-day surge in more than six years on the back of a profit upgrade.

Shares in Pacific Brands shot up 27.7% to a one-month high of 41.5 cents when management lifted its underlying earnings before interest and tax (EBIT) guidance to between $63 million to $65 million for the year ended June 30, 2015. This compares to its earlier guidance of $57.4 million to $63 million.

The news couldn't come soon enough as the stock had slumped to 32 cents last week – its lowest level since March 2009.

What's perhaps the more significant takeaway from the news is that the stronger-than-expected result is driven by both topline growth and a lift in productivity.

Sales from ongoing businesses for the year are tipped to be 5.3% higher although the headline figure will fall in absolute terms due to divestments made in the first half of the financial year, while good cost control is helping protect group margin in the face of strong competitive pressures.

The news could be enough to spark a long-awaited re-rating in the stock as analysts' expectations are set low with consensus forecasts penciling in a 30% drop in underlying earnings per share (EPS) for 2014-15 and a further 3.5% slide to 3.91 cents for the current financial year.

EPS for 2014-15 is still expected to contract due to the divestments, but analysts will probably be paring the expected decline and could even upgrade the 2015-16 figure to show modest growth.

Even on a modest 5% increase in EPS, the stock looks undervalued as it will be trading on a price-earnings multiple of around 10x.

More significantly, the earnings news will bolster confidence that management can restart dividend payments this financial year (it suspended dividends for 2014-15).

Pacific Brands could pay a 2.7 cent a share dividend over the next 12 months and that would put the stock on a yield of 6.5% before franking.

I think Pacific Brands makes an attractive buy at 41 cents or below.

While Pacific Brands is not seen as a likely takeover candidate, one can't rule it out either even with today's share price surge as I am expecting to see more corporate activity for the current financial year.

After all, most weren't expecting a takeover bid for adventure gear retailer Kathmadu Holdings Ltd (ASX: KMD) either.

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Motley Fool contributor Brendon Lau has no position in any stocks mentioned. Follow me on Twitter - https://twitter.com/brenlau The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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