Bug busting buying opportunity

My 2016, 2017 and 2018 portfolios have put in vintage performances by generating to date total returns of 47 per cent, 37 per cent and 24 per cent, respectively, outperforming the FTSE All-Share index, which has returned 40 per cent, 13 per cent, and 4 per cent for those respective years.  

I have achieved these healthy returns by targeting and stock-picking a small portfolio of 10 undervalued and under-researched small-cap stocks each year to give me an edge over other investors. I have also monitored the performance of the constituents on a regular basis to take advantage of repeat buying opportunities when they occur. Bearing this in mind, I think there is one to exploit in the shares of Bioquell (BQE:325p), a provider of specialist microbiological control technologies to the international healthcare, life science and defence markets.

I included the shares at an average buy-in price of 125p in my 2016 Bargain Shares Portfolio, and last advised running profits at 330p just after the company delivered an eye-catching set of full-year results (‘Bargain Shares: Beating the market’, 12 Mar 2018). Buoyed by a 13 per cent increase in revenue to £28.5m in its bio-decontamination business, Bioquell’s underlying pre-tax profit soared by more than 75 per cent to £2.9m last year.

The double-digit sales growth highlights the payback from prior investment made in new products such as Bioquell QUBE, an aseptic work-station incorporating hydrogen peroxide vapour (HPV) technology that provides an aseptic environment for sterility testing and the production of toxic, intravenous oncology drugs; and an ergonomic fixed, wall-mounted bio-decontamination system. It also reflects a benign market backdrop for Bioquell’s products and one being underpinned by the requirement for customers to achieve and maintain regulatory compliance, the growing threat posed by antibiotic resistance, and ongoing growth in research and small-scale production associated with cell-based healthcare products.

Operational gearing and currency tailwinds

The fact that profit growth has been outpacing sales growth illustrates both the operational gearing of the business, and the tailwind from sterling’s weakness that boosts margins earned, with around 80 per cent of sales derived from overseas. The revenue mix last year was split as follows: 32 per cent of sales were from the Americas; 12 per cent from Asia Pacific; and the balance from Europe, the Middle East and Africa. That’s worth noting as sterling has taken a tumble against the US dollar since my article was published in early March, falling from £1:$1.39 to below £1:$1.32. It’s been roughly flat against the euro, albeit volatile.

My view is that if sterling stays at current levels for the remainder of the year then there is going to be an additional positive translation effect on Bioquell’s international sales and profits, which should drive earnings upgrades on what I consider as conservative analyst forecasts for the current financial year. Chris Glasper of broking house N+1 Singer forecasts point towards Bioquell delivering 8 per cent higher revenue of £30.9m in 2018 to produce cash profit of £5.5m, pre-tax profit of £3.2m and EPS of 11.1p.

The other factor worth flagging up is Bioquell’s cash-rich balance sheet, and its strong cash generation. Net funds surged last year from £8.8m to £14.6m, a sum equating to 20 per cent of the company’s market capitalisation of £72.4m. Since then, £856,000 has been spent repurchasing 1.2 per cent of the issued share capital in an earnings enhancing buyback programme, the cost of which will have been largely offset by the cash proceeds from the disposal of two non-core business. Furthermore, with planned capital expenditure of £2m below the £2.4m non-cash charges for depreciation and amortisation of development costs, and given that a high percentage of cash profits are being converted into operating cash flow, then expect the cash pile to increase by around £3m this year.

New target price

Strip out a likely net cash position of £17.6m at the year-end from Bioquell’s market value of £72.4m, and its enterprise value of £54.8m equates to 10 times conservative looking cash profit forecasts. To put this valuation into perspective, it’s half the rating of Tristel (TSTL: 332p), a maker of infection prevention, contamination control and hygiene products. I spotted the investment potential of Tristel four years ago (‘Clean up on superbugs’, 9 May 2014), and investors have warmed to the investment case which is why shares in that company have risen 450 per cent since then. The combination of earnings growth and multiple expansion have been the key drivers. The same combination should be the drivers of the next leg in Bioquell’s re-rating.

Indeed, with the risk to earnings skewed to the upside, the currency matrix working in Bioquell’s favour, market drivers supportive, new products in demand, the business highly cash generative, and the shares trading on half the rating of peers, then I feel there is a buying opportunity to exploit ahead of next month’s first-half pre-close trading update. My new target price is 450p to place a value on Bioquell’s equity of £105m, and is based on a multiple of 15 times conservative looking 2019 cash profit estimates of £5.8m to enterprise value. At an offer price of 325p, Bioquell’s shares rate a buy.

■ Simon Thompson's new book Successful Stock Picking Strategies was published on 15 March and can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 to place an order. It is being sold through no other source and is priced at £16.95 plus £2.95 postage and packaging. 

Simon's second book Stock Picking for Profit has now been reprinted and is available to purchase online at www.ypdbooks.com for £16.95, plus £2.95 postage and packaging, or by telephoning YPDBooks on 01904 431 213 to place an order.