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Top broker is predicting this underperforming small cap to race ahead this year

Shares in MotorCycle Holdings Ltd (ASX: MTO) have bounced strongly today after hitting a five-month low and at least one broker believes this is the best time to hop onto the stock.

The value of the motorcycle dealer jumped 5.8% to $4.02 as we head into the close but it is still lagging the broader market after posting a disappointing first half result.

MotorCycle Holdings has delivered gains of a little over 1% over the past year when the All Ordinaries (Index:^AORD) (ASX:XAO) is up around 6%. Things have also been tough for fellow auto dealer AP Eagers Ltd (ASX: APE) which has reversed by 3.5% over the same period.

On the upside, there’s lots of room for MotorCycle Holdings to race ahead. The ex-market darling had rallied by around 30% before the start of the February reporting season as investors braced for a bad result due to tough industry conditions.

However, Morgans thinks this is a good time to buy the stock. While the results were disappointing, they were ahead of the broker’s expectations and MotorCycle Holdings actually outperformed the broader industry.

“While trading conditions remain subdued, MTO noted that new bike volumes in January were up c2% while February is flat to date, with early signs showing that the sharp (-c20%) declines seen in 1H18 have eased,” said Morgans who has a price target of $5.17 on the stock.

There are other reasons to feel upbeat about FY19. Insurance income commission has been rebased lower and the weak profit result will provide a low hurdle for the group to beat going forward.

Furthermore, earnings will be boosted by the full year contributions from recent acquisitions, which should benefit from the economies of scale that comes from being part of the MotorCycle Holdings network.

The group will also have a new revenue streams from second hand bike sales in MCA retail stores and sales of a white-label finance product through its Allied Credit joint venture.

Investors shouldn’t rule out other dealership acquisitions too, which will provide another uplift in group earnings.

Given these potential tailwinds, Morgans thinks the stock is cheap as it is trading on a FY19 price-earnings multiple of 12 times.

That is arguably too low considering that consensus is forecasting a 30% increase in FY19 earnings per share and a yield of around 5% before franking credits.

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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.