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After 60 per cent gain, be cautious of this small-cap Add to ...

Investors in one of Canada’s largest laundry and linen processing companies have made a 60 per cent profit over the past two years, but the stock now appears to be stalled until the company lands more business.

Analysts say Edmonton-based K-Bro Linen Inc. stock has run out of steam in the face of rising energy and labour costs, alongside modest growth. At least four analysts have downgraded the stock to a “hold” or equivalent rating since May 8, when K-Bro reported a 2 per cent increase in first-quarter revenues and a 26 per cent slump in earnings per share (EPS), compared to the same period last year. That followed a 2.4 per cent rise in revenues and 23 per cent drop in EPS for fiscal 2013 compared to a year earlier.

The stock is also considered expensive, trading at 22 times next year’s earnings.

“The valuation is just a little bit stretched now relative to the merits of the company,” said National Bank Financial analyst Trevor Johnson, who lowered his recommendation to “sector perform” from “outperform” and has a $41 price target on the stock.

He expects the company will grow more next year when it opens a new facility in Saskatchewan, “but for now we think the stock’s nice trajectory takes a pause.”

Among seven analysts that cover the stock, five now have a “hold,” while two say “buy,” according to interviews and Thomson Reuters data. The consensus target over the next year is $41.18. That’s slightly above its record high of $40.55 on March 27. The shares closed Friday at $38.79 on the Toronto Stock Exchange, giving the small-cap a market capitalization of $275-million.

Acumen Capital analyst Brian Pow lowered his rating to “hold” and his target to $39.50 from $42.10, citing higher energy costs and expenses to grow its business.

K-Bro recently upgraded its Edmonton facility at a cost of $27.8-million. It’s also building a new $22-million plant in Regina, after being awarded a 10-year contract with Health Shared Services Saskatchewan.

K-Bro has a “clean balance sheet and good long-term growth prospects,” Cormark Securities analyst Sarah Hughes said in a research note. She dropped her recommendation to “market perform,” citing slower growth and “lack of near-term catalysts.” She kept her price target at $41.50.

Euro Pacific Canada analyst Douglas Loe downgraded K-Bro to a “hold,” calling it “a valuation call” and cut his target to $38.75 from $40.50. Still, he said in a note, his colleagues “remain fans of K-Bro’s competitive status in the Canadian linen/laundry service industry.”

K-Bro was founded in the early 1950s as cloth diaper laundering company. It currently has eight facilities in seven Canadian cities from B.C. to Quebec. Today, about 68 per cent its revenues are from health care clients such as Alberta Health Services, Fraser Health Authority and Vancouver Coastal Health Authority, while the other 32 per cent are from hospitality customers such as hotels.

Laurentian Securities analyst Michael Glen is keeping his “buy” recommendation, saying K-Bro is a stable business with strong management.

“A lot of people do view it as a slower-growth company, but that doesn’t bother us. We still see a tremendous amount of opportunity in front of them,” said Mr. Glen, who has a $42.50 price target. He also sees more expansion opportunities in regions such as British Columbia and Atlantic Canada.

Michael Bowman, portfolio manager at Wickham Investment Counsel Inc., said his firm has owned the stock and would consider buying it again if it dropped to around $36.

“It has a lot of things going for it,” he said, citing the company’s dominant market position as well as its “ very simple” and “non-cyclical business.”

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