Goodbody forecasts further gains for the Irish small cap market, writes Siobhán Creaton.

Goodbody Stockbrokers is recommending IAWS, Kingspan, Independent News & Media, Tullow Oil and Eircom as representing the best growth stories among small Irish stocks.

In its Small Companies Review 2004, the brokers said these key picks have been selected based on quality of earnings, valuation, potential for returns through dividends and share buybacks and balance sheet growth.

In terms of the potential to offer quality earnings growth, the brokers suggests that IAWS, United Drug and DCC offer the best options for investors. Each of these companies have generated uninterrupted double-digit earnings growth over the last 10 years.

When valuations are considered, Goodbody selects Independent News & Media, IAWS and Tullow Oil. Investors looking for dividends or other returns should consider Viridian, Eircom and C&C. It also notes Independent News & Media as having a particularly generous dividend yield while companies like Kingspan, IAWS and Paddy Power have considerable scope to step-up cash returns to shareholders.

Of the companies that have been restructured over the past 12 months and are positioned for growth, the brokers mention Jurys Doyle, Waterford Wedgwood and IWP as the only companies that appear to have relatively high debt levels. Goodbody said IWP is the only real concern in the near-term.

Irish smaller capitalised companies have outperformed national, international and several European small cap markets and say it still sees scope for further upside. The review covers 34 companies with a market capitalisation of €1.5 billion or less.

During 2003 its Irish smaller cap index was up 36.9 per cent compared to 22.4 per cent for the main ISEQ index and a 13.6 per cent increase for the FTSE 100. It also outperformed the majority of European smaller cap indices during 2003 and continue to outperform this year. Since January, Goodbody says the index has risen by 11 per cent and it suggests investors can still find value.

Among its five key stock recommendations, Goodbody says that IAWS has positioned itself in some of the fastest growing sectors in the food industry in Britain, Ireland and in the US. Its Cuisine de France brand is increasing its supply base in Ireland and the UK while La Brea is growing at 25 per cent annually and additional capacity is being built in its Hortons joint venture in Canada as well as La Brea.

The company does face some challenges, however. The increasing popularity of low carb diets and concerns about calorie intake along with the normal competitive pressures mean that the strong historic growth rates cannot be taken for granted.

Notwithstanding these challenges, Goodbody believes that the next few years will see strong earnings growth at IAWS and upgrades are far more likely than not.

Kingspan is facing a different dynamic in the current year which leaves it well on target to return to double-digit growth and end a disappointing two-year period for the company.

Its better performance reflects stability returning to the raised access floors business. Earnings forecasts are also underpinned by the prospects of a sustained cyclical upturn in non-residential construction markets and the ongoing benefits of substantial investment in additional capacity. The brokers have set a 12-month price target of €6, a 20 per cent increase in the current price.

Independent News & Media's shares have rebounded strongly since the company was re- financed in the last year with the brokers suggesting there is still scope for further upside.

"In terms of the key drivers for the share price over the next 12 months, we believe that the performance of the group's Irish and UK operations are the most likely sources of earnings upside," according to the report.

The current trends in the relative commodity prices are the key factors underpinning Goodbody's forecasts for Tullow Oil.

It is forecasting that 66 per cent of Tullow Oil production in 2005 will be oil and 60 per cent will emanate from regions outside of the UK.

Newsflow on the exploration portfolio has the potential to drive the share price over the coming months, according to the report.

The Goodbody report says that while Eircom is facing a challenging revenue outlook with regard to Ireland's fixed line market, the company's higher dependence on infrastructure-based revenues and the lack of any real infrastructure based competition gives it a more resilient revenue model compared to its European peers.

In the coming months, as management engage with investors to better articulate these differences and as the company continues to deliver results that meet or beat expectations, Goodbody expects sentiment to change and that a re-rating will follow.

Stocks the brokers believe are overvalued include Waterford Wedgwood, Trinity Biotech, Readymix and Icon.