Finding shares with over 40% upside within two years may be more difficult now that the FTSE 100 is trading near to a record high. Shares across the index have enjoyed significant price rises in recent months, with weaker sterling being central to their gains. Despite this, there are a number of stocks which appear to be undervalued given their future growth potential. Reporting on Monday was one such company, which could be a strong performer over the medium term.
The company in question is a collagen producer for the food industry, Devro (LSE: DVO). It recorded a rise in revenue of 4.7% in 2016, with exchange rate benefits offsetting lower sales volumes. Its underlying EBITDA (earnings before interest, tax, depreciation and amortisation) was £9.1m ahead of last year at £58.8m. It benefitted from lower input prices, which could continue in the coming months.
In terms of growth potential, the company’s capital investment projects offer bright future prospects. The commissioning and start-up of new plants in China and the US is now complete, which could provide it with improved financial performance in the long run. Furthermore, the Devro 100 programme has been initiated to specifically improve the company’s top and bottom line. This will focus on improving the company’s sales capabilities, generating higher manufacturing efficiencies and introducing a new range of differentiated products.
Capital gain prospects
While Devro’s bottom line is forecast to fall by 2% this year, the company is expected to return to growth in 2018. Its earnings are expected to rise by 16% and considering its shares trade on a price-to-earnings (P/E) ratio of 13.6, it appears to offer value for money. In fact, given that the company’s shares have historically traded on an average P/E ratio of 17.5 during the last four years, there could be considerable upside ahead. If Devro meets its forecasts for 2018 and its shares revert to their average P/E ratio, they could offer capital growth of as much as 46% over the medium term.
Clearly, such a high rate of growth may seem unlikely. But since the company is investing heavily in generating efficiencies, improving its product line and providing improved sales practices, it could prove to be an excellent investment between now and 2019.
Additionally, the food production sector could offer defensive appeal during an uncertain period for the stock market. Sector peer Cranswick (LSE: CWK) has proved popular with investors in the last year, as evidenced by its share price growth of 22%.
However, its shares appear to be overvalued when compared to those of Devro. For example, Cranswick is forecast to record a rise in its bottom line of 10% next year, followed by 6% the year after. This is a similar growth rate to its sector peer, but Cranswick trades on a P/E ratio of 20.6. This indicates that while the two companies may offer attractive defensive profiles, Devro seems to have greater capital growth potential resulting from an upward re-rating.
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Peter Stephens has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended Devro. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.