Three underrated shares to buy now

They may not make the headlines but, with new products and lucractive contracts in the pipeline, these three stocks are exciting prospects. City analyst John Cornford picks the shares you should buy now before other investors catch on.

Photo-Me International (PHTM, 89p)

I tipped this firm in November, when it was the subject of bid talks. These have since been called off, but I still rate the shares a buy. The firm, which makes photo-processing equipment and operates photobooths, now plans instead to return significant surplus capital' (and perhaps spin-off parts of its business) as a better way of maximising shareholder value.

About 17% of the shares changed hands on this news, but most major investors involved in the talks are still there a full 86% of the firm is held by only 12 investors. It seems small shareholders may once again have mis-timed their selling.

Photo-Me plans to borrow money to pay out surplus capital thought to come to more than £100m (27p per share), though it could be more. The remaining group, loaded with debt, will be worth less. Accounting for interest on the £78m Photo-Me will take on to make the payout (allowing for the £22m net cash on the balance sheet already), the shares are valued at 17 times adjusted earnings forecasts for the current year. The institutions wouldn't be staying in if they didn't think that was too cheap.

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The rating ignores the fact that the remaining firm will be cash generative (so it can take on borrowings that it can pay down quickly) and also highly geared to any recovery in minilab sales. The first sign of the latter might be a recently announced follow-on order from 6,200-branch US pharmacy chain, CVS.

Photo-Me says it is on track to meet second-half profit forecasts and the prospect of sales next year also looks more promising. With the shares underpinned by what looks like strong chart support, there seems to be only one way for them to go.

Ashley House moves to Aim

Ashley House is to join Aim from junior stock exchange Plus (formerly Ofex) in mid-January and it's well worth a look. The firm designs and builds surgeries and medical properties and has a strong position with NHS trusts. Clients can choose to own properties themselves, or rent through its property development arm, Ashley House Properties (to be renamed AH Medical Properties).

The rents GPs pay for their surgeries are guaranteed by the trusts, which is what makes medical property so attractive. But listed opportunities are limited, so Ashley House will have rarity value.

Turnover in the last six months was up threefold on three years ago. Profits this year are likely to be over £3m, against £716,000 in 2005, giving earnings per share of more than 9p. The firm has 18 properties under construction, about double that of two years ago. It has announced a tie-up with Australian-listed Babcock & Brown, a major operator in NHS infrastructure and private finance initiative projects. Babcock and Ashley House have identified potential NHS projects valued at more than even Ashley House's fast-growing pipeline and the future looks bright.

The shares will probably list at more than 120p, with plans to raise £5m of new funds. This should make for better liquidity than when the shares were on Plus. I think they will be in demand.

Corac (CRA, 36.5p)

Engineering technology group Corac listed on Aim in 2001 at over 100p, when it was hoped it would rapidly break even. But the group still hasn't made money, with losses of around £2m a year for the last four years, about half of which is due to research and development spending. The shares have cycled from lows of 25p to highs of around 50p as investors repeatedly get excited about its potential, then lose interest. But a breakout should occur if licence income starts in earnest, probably in 2008/2009. Corac, formerly part of Brunel University, has already licensed one product for engineering seals to Aesseal, the fourth-largest firm in the sector. Its oil-free' air compressor has just been shipped to a major continental engineer, which reports a good reception by customers.

But its biggest opportunity could be a compressor it has designed for gas wells that are nearing the end of their lives. The technology could extend gas recovery by up to 40% on 100,000 of the world's 600,000 wells. Conoco, ENI, and Repsol have been part-funding development that will see full-scale trials this year and possible deployment in 2008.

There's a risk the programme may not reach the commercial stage (Shell withdrew on completing phase I last year). But with so much at stake, the participants will strive hard to make it succeed. Break-even might be two years away, but Corac's market cap of only around £27m is tiny compared to the vast potential of any one of the three markets it is targeting. This is what persuaded institutions to stump up more cash last year at 32p. And with more news expected this year, the shares look bound to tick up at some stage.

John Cornford is a City analyst