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Deutsche Bank: This small cap is a buy and has room to move higher

Shares in Cardno Limited (ASX: CDD) surged for a second day following the release of its half year results that prompted Deutsche Bank to upgrade the infrastructure and environmental consultancy to a “buy”.

The stock jumped 1.8% higher to $1.40 in afternoon trade after surging nearly 12% on Monday after management posted a 30% uplift in first half earnings before interest, tax, depreciation and amortisation (EBITDA) to $30.3 million.

However, gross revenue dipped to $543.4 million in the six months to end December 2017 compared with the $575.7 million Cardno posted in 1HFY17.

The market isn’t concerned about the top-line though, not when margins are expanding as quickly as that. Cardno’s cost cutting program is working like a charm and there are reasons to think that revenue growth will soon follow given Cardno’s exposure to strong growth sectors.

Infrastructure spending is booming in Australia and the US (where Cardno has a significant market presence) and the consultancy is likely to pick up more work in the latter market as US economic growth is expected to accelerate this year and next.

Unfortunately, its US operations aren’t firing on all cylinders as management admits there is a lot more work to do to get it into prime condition as the margin on its Americas business sits at around 3.6% when Asia Pacific is at 9%.

But the glass is certainly half full with Cardno’s interim EBITDA coming in at 6% above Deutsche’s forecast and with management reporting a 7% increase to its backlog of work that is worth $813 million.

“CDD is well positioned to take advantage of improving Australia and US economic conditions, with its exposure to infrastructure, O&G [oil & gas] and construction providing a strong cyclical tailwind,” said Deutsche who has a $1.80 price target on the stock.

“FCF [free cash flow] generation is strong and the BS [balance sheet] is net cash, providing scope for acquisitions. Management has delivered a very well executed turnaround and we see upside risks to earnings over the next 1-3 years.”

Cardno is on track to deliver a large 70% plus uplift to its full year earnings per share and is likely to post 20% plus growth in both FY19 and FY20.

The stock looks inexpensive in light of its growth profile as it is trading on a FY19 price-earnings of around 15 times.

Cardno still has quite a bit of room to play catch-up even with the latest share price surge. The stock is up around 21% over the past 12-months but that is nothing compared to other companies that provide services to the infrastructure and resources sectors.

For instance, shares in Emeco Holdings Limited (ASX: EHL) and NRW Holdings Limited (ASX: NWH) have gained 254% and 115%, respectively, while Worleyparsons Limited (ASX: WOR) has jumped 65% over the same period.

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Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. 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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