Carrying on with my reviews of "cheap" Aussie small caps coming into reporting season...

Background

Essa Australia is a small company specialising in the manufacture of laboratory equipment for the sampling and testing of minerals. Initially two separate business, Essa and Labtechnics (formed 1980Õs), the two companies merged in 1996 to form Labtech Essa. The business listed on the ASX in October 2004, raising $5m through the issue of shares at 25cps. Listing was undertaken primarily to enable the company to seek faster organic growth and acquisition activities. The vendor retained 55% of shares on issue Ð since reduced slightly.

The business can be divided into Òstandard equipmentÓ, Òwear and spare partsÓ, Òsampling equipmentÓ and Òlab automationÓ. With the exploration boom pushing mineral testing laboratories to run at maximum capacity, the demand for these products should be high. Looking forward, the main thrust of organic growth is in the supply of higher margin, automated and robotic equipment. The company has also expanded geographically in recent years, with offices in South Africa, Europe and Chile. The company web-site www.labtechessa.com provides an excellent source of information including Patersons reports (Patersons having been lead broker for the issue).

Current Status

Labtech Essa reports having been profitable for every year of the last ten years. From available data, it appears that profits have also grown in every year from at least 2001. The 2005 NPAT of $1.87m came in ahead of prospectus forecast ($1.75m), putting the company on a P/E of 8.2 at the current share price of 35cps. Dividends of 2.6cps were paid, giving a yield of 7.4% plus franking credits. Revenue grew by 38% - a rate that appears somewhat higher than the five year average growth rate of 16%.

However, in the first quarter of 2006, the company experienced some operational hiccups that impacted on profit and resulted in a profit downgrade. Despite this, a recovery was made in the second quarter and half year profit of $0.72m was reported. Currently Essa are forecasting full year revenue to grow slightly to $17.8m, with NPAT falling slightly to $1.65m (largely, it appears, due to higher than normal tax payment). Dividends are forecast to fall only slightly to total 2.50cps (half of which was paid at HY). Achieving these results suggests a forward P/E of 9.3 and yield of 7.1% - cheap for a company with a 10 year profit history, at least 5 years of double-digit growth and with net cash of $1m.

Long Term Prospects

The current resource exploration boom should be beneficial to Essa, particularly given the reported squeeze on laboratories. This should be leading to a period of laboratory upgrades and, combined with skilled labour shortage, automated systems should be high on the cards. In fact, Essa is forecasting growth of 160% in sales of automated equipment for the 2006-2007 year Ð up from 32% in the current period. Unfortunately, it is not clear what base this off, although it has been mentioned that automation projects typically fall in the range $0.5-$2.0m project value.

Around 25% of revenue is generated from sales of replacement parts which provides some underlying consistency to the business growth.

Summary

Essa appears to provide low risk leverage to the resource boom. The shares currently appear undervalued and show prospects for good growth and yield. Based on a continuation of recent growth rates over the next 5 years, a valuation of 64cps seems appropriate. From a sentiment perspective, I would expect the achievement of full year forecast would move the price to around 45cps, with possible upside if the forecast result is exceeded.