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One Undervalued Growth Share?

The price-earnings-growth (PEG) ratio can be useful for pointing out situations in which the market might have overlooked shares that are experiencing strong growth in their businesses. Such shares, also known as growth shares, have historically grown sales and profits at very fast rates – usually in the double digit percentages.

So, what the PEG ratio does is to compare the price-earnings ratio of a share with its historical growth rates. Mathematically, it’s computed by dividing the price-earnings ratio with a share’s historical earnings growth; generally, anything below 1 could point to potential situations whereby a share’s growth might be overlooked by the market.

Using this valuation tool, there’s a particular share that stands out and that’s none other than oil & gas outfit Ezion Holdings (SGX: 5ME). At its current price of S$2.25, Ezion carries a trailing price-earnings ratio of 13.5. However, with its 65.7% compounded annual growth in earnings from 0.71 Singapore cents per share in 2007 to 16.7 cents in the first quarter of 2014, the company carries a historical PEG ratio of just 0.2.

There’s also another interesting facet to the earnings growth of Ezion. In 2007, the company had made a switch in its business model. Back then, it was a loss-making company that focused on mechanical and electrical engineering-design services. In that year, it decided to pare off that part of the business and switched to a completely new model; that of providing logistics and support services to the offshore oil & gas industry. Today, Ezion owns a fleet of different rigs and vessels that help maintain, repair, upgrade, and remove offshore platforms in addition to providing other logistical functions.

The “mid-career” switch for Ezion has worked wonders for the company – as shown in the table below – as its earnings have improved with alarming speed in each consecutive year since the switch was made. That is also the other interesting facet that was referenced earlier: Companies that are able to grow through both booms and busts might just have durable businesses that can withstand the test of time and ultimately reward shareholders.

Year Earnings per share (Singapore cents)
2004 -1.07
2005 -0.55
2006 0.14
2007 (switch in business model) 0.71
2008 1.04
2009 2.29
2010 6.02
2011 8.79
2012 9.72
2013 20.7
First quarter of 2014 21.1

Source: S&P Capital IQ

2007-2009 was when the Great Financial Crisis hit the global economy badly and Singapore wasn’t spared either with the Straits Times Index (SGX: ^STI) feeling the full brunt of it, falling by almost two-thirds from peak-to-trough. But even so, Ezion has managed to plow through those testing times with increased profitability.

An obvious question comes next: Is the market underestimating this company? That can be a tough call to make. As it stands, Ezion has US$1.275 billion worth of borrowings while having only US$185 million in cash. That’s a heavily-levered balance sheet the company has there, and could warrant some caution from investors. In addition, having been so successful over the past six to seven years providing support services to the oil & gas industry, Ezion now has ambitions to move upstream in the industry to become an exploration and production play itself. While such a move might seem a logical extension of its business activities, it’s still considered unchartered territories for Ezion and that could be a source of risk too should the venture fall flat.

All told, Ezion’s low PEG ratio and historical earnings growth might make it seem like an undervalued growth share. But at the same time, there are legitimate sources of risk pertaining to the company that could justify such a low valuation.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn’t own shares in any companies mentioned.