Why these 2 profit downgraders have found favour with brokers

This confession season has thrown up a few ugly surprises but investors may have over-reacted to two of these sinners.

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The share prices of companies that are owning up to a worse-than-expected result during this “confession season” have been punished, but some of these profit sinners could redeem themselves, according to two brokers.

The confession season is a period where listed companies have a chance to review their end of financial year accounts and update investors if profits are likely to miss expectations ahead of next month’s profit reporting season.

Both investment and accounting admin software provider Class Ltd (ASX: CL1) and agriculture products and rural services group Elders Ltd (ASX: ELD) have issued profit warnings that have triggered a big sell-down in their share prices.

Class fessed up to investors that it had signed up fewer than expected Self-Managed Superfunds (SMSFs) to its platform in FY18 than anticipated and the collapse in its share price means the stock is trading 27% into the red over the past 12-months compared with a 10% gain by the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index.

The company reported that 4,526 new SMSF accounts (on a net basis) have signed up for its service in the June quarter, which is the weakest since 2015 despite Class offering a six-month fee waiver for new customers.

But the news isn’t as bad as the market thinks, according to Morgans who has reiterated its “add” recommendation for the stock as its lowered its price target by 4 cents to $2.73 a share.

“While the growth rate in the second half of FY18 was below expectations, Class grew paying accounts by 16% yoy [year-on-year] over FY18. Over the financial year Class grew its share of SMSF accounts on platform 2.3 percentage points to 26%,” said the broker.

“We retain a positive view on Class. While short-term regulatory and competitive pressures have slowed the company’s growth rate, in our view the company still has the ability to deliver sustained double-digit earnings and free cash flow growth.”

The market may have also overreacted to the trading update by Elders with Bell Potter upgrading the stock to “hold” from “sell”.

That seemed to have been enough to trigger a 2.1% rally in the stock to $7.21 ahead of the close, although the stock is still down 14% since the shock announcement last Friday.

Management is forecasting underlying net profit to range between $59 million and $63 million for FY18 and that’s either at the low end or below what analysts were tipping.

You can blame bad weather for Elders’ misfortunes with the poor start to the winter cropping season and falling cattle prices. There is also a 50/50 chance of an El Nino this year.

But no one should be surprised by the unfavourable weather given that crop protection and seed company Nufarm Limited (ASX: NUF) had issued similar warnings last month.

“We initially downgraded ELD to Sell reflecting a view that the share price was re-rating at a time when the underlying drivers of the business were deteriorating… and implying an unrealistic earnings outcome for FY18e,” said the broker.

“While we continue to see some downside risk to 1H19e in the form of summer cropping conditions, the recent share price correction has seen a compression in the FY19e EV/EBITDA multiple to a more appropriate level.”

It’s no screaming buy but at least it looks like the bad news is baked into Elders’ current share price.

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Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of Class Limited. The Motley Fool Australia has recommended Elders Limited. 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 Scott Phillips.

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