This small-cap growth stock could be undervalued by as much as 100%

Updated: 
Barbados

It has been a rough 12 months for shareholders of Elegant Hotels(LSE: EHG). The company, which owns and operates hotels and restaurants on the island of Barbados, saw the value of its shares decline by around 40% over the summer last year. That was after management warned alongside H1 results that a reduction in customer demand due to political uncertainty in the UK and the spread of the Zika virus would hit full-year earnings.

As it turns out, revenue for the year declined from $60.1m to $57m, and the revenue per available room decreased by 6.7%. Occupancy fell by 5.5% to 62.9%. Nonetheless, despite sluggish demand, the company has continued with its expansion plan and announced today that it had completed the $11m acquisition of Treasure Beach Hotel in Barbados.

Still, it looks as if things are looking up for the firm. In a trading update issued at the end of February, Elegant informed investors that trading during the first two months of the year was in line with management expectations. While the announcement did not detail management's expectations for the year, the key takeaway from this trading update is that at least performance has not deteriorated further.

Thanks to acquisitions, City analysts expect the company to report a high single-digit increase in revenue for the financial year ending 30 September. However, pre-tax profit is expected to decline to £9m, from last year's reported figure of £12.2m. Last year the company's earnings benefited from a one-off property investment gain. For the 2017 financial year, City analysts have pencilled-in earnings per share of 7.9p, down 22% year-on-year. After 2017, analysts believe Elegant's outlook is set to improve dramatically. For the following fiscal year earnings per share could increase by as much as 18% as revenue ticks higher by 9%.

Undervalued opportunity?

It seems the market does not believe that the company can hit City targets for growth. At the time of writing, shares in Elegant are trading at a forward P/E of 10.8, which is around half of the multiple of 22 times forward earnings awarded to larger sector peer Intercontinental Hotels Group. This valuation seems unwarranted, especially considering Elegant's growth potential and strong balance sheet. 

For the year ending 30 September 2017, the company reported loans and borrowings of approximately $46m compared to a cash balance of $6m and property worth $145m. As well as a strong balance sheet, the company is also highly cash generative, generating $17m of cash from operations during the last financial year. Of this total, $9.5m was returned to shareholders via dividends and at the time of writing shares in Elegant currently support a dividend yield of 7.1%.

The bottom line

So overall, even though the past year has been full of uncertainty for Elegant, it looks as if the company is set for steady growth. However, despite the company's growth potential, cash generation, strong balance sheet and dividend yield, the shares still trade at a deep discount to sector peers. With this being the case, I believe Elegant looks to be a highly attractive undervalued growth stock.

Finding the best stocks

Uncovered growth stocks like Elegant can produce huge returns for your portfolio but with all small-caps, you need to do your research first before jumping in. To help you separate the wheat from the chaff, and avoid the market's worst companies, we've put together this new free report.

The report is a collection of Foolish wisdom, which should help you improve your investment returns and avoid needlessly losing too many more profits. So to help improve your investment process today, click here to download.

Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.