- PaperlinX removed from S&P/ASX200 index - Institutional investors less likely to look at the stock - Morningstar retains Avoid rating, expects tough conditions to continue

By Chris Shaw

Following the March quarterly re-balancing of the S&P/ASX200 index, PaperlinX ((PPX)) was removed from the index as a market capitalisation at present of around $200 million no longer justifies inclusion.

Morningstar suggests the index removal makes PaperlinX an even more unattractive investment, as not only operates the company in an unattractive industry, but there are now even fewer institutional investors able or willing to invest in the stock.

While PaperlinX offers leverage to the European and North American economies, Morningstar suggests earnings are unlikely to recover until both of these economies deliver sustained recoveries. Earnings improvement will also require an improvement in paper volumes.

Morningstar sees scope for a modest improvement in earnings in the second half of FY11, but with market conditions still difficult a breakeven net profit after tax result is forecast for FY11 as a whole.

At the same time Morningstar has adjusted its earnings model for PaperlinX to reflect some reductions to long-term estimates and a higher cost of equity. The result is earnings per share estimates (EPS) of 0.0c this year and 1.4c in FY12.

These estimates compare to consensus EPS according to the FNArena database of 1.0c and 4.1c respectively.

The changes to Morningstar's forecasts mean a reduction in valuation for PaperlinX to $0.38 from $0.48 previously. Morningstar rates PaperlinX as Avoid. Views among brokers in the FNArena database are more mixed as this shows PaperlinX is rated as Buy twice, Hold three times and Underperform once.

The Buy ratings, which come from BA Merrill Lynch and Deutsche Bank, reflect expectations of price and margin improvements as conditions improve in PaperlinX's markets. Credit Suisse sides with Morningstar however, suggesting conditions remain difficult for the company and any fix in terms of sustainable earnings improvement is likely to take more time.

The consensus price target according to the FNArena database stands at $0.69. Targets are widely spread, ranging from Deutsche Bank at $1.10 down to Credit Suisse at $0.40.

Shares in PaperlinX today are slightly weaker, trading down 0.5c at $0.33 as at 11.40am in a market that is trading deep in the red. Over the past year PaperlinX has traded in a range of $0.32 to $0.84. The current share price implies almost 113% upside to the consensus target in the FNArena database. Such gaps more often indicate a potential value trap instead of a genuine bargain opportunity.

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