Sedgefield-based Kromek (KMK:25p), a radiation detection technology company focused on the medical, security and nuclear markets, has announced yet another contract win and one that has major significance.
The company has been awarded a ground breaking five-year supply contract worth a minimum of $7.8m (£6m) by an existing OEM customer, a leading company in x-ray imaging systems, for its next generation baggage security screening detectors. Kromek's proprietary cadmium zinc telluride (CZT) technology is designed to enhance the detection of an extensive range of threat materials and will be installed within the client’s existing baggage screening units to improve their accuracy and efficiency. The contract starts immediately and is unlikely to be the last as the need to improve border security could easily persuade rivals to adopt the cutting edge technology too, a point made by analysts Paul Hill and Andy Edmond at Equity Development.
The contract takes the total awards won by Kromek to around $20m over the past nine months. It also comes at a time when there is a strong tailwind driving the $2bn global security screening market in air transportation, ports, borders and freight. Analyst Robin Byde at Cantor Fitzgerald rightly points out that annual growth of around 5 to 6 per cent in the security screening market is being driven by multiple factors including:
■ Evolving security risk environment with “smarter” devices and globalised threats.
■ Rising regulatory requirements, particularly in the USA, Europe and Asia.
■ Growing numbers of passengers and freight shipments. For instance, International Air Transport Association (IATA) forecasts a compound annual growth rate (CAPR) of 4.9 per cent in passenger numbers to 2040 and CAGR of 2.3 per cent in air cargo shipments in the same period.
■ Globalisation of trade and increasing recognition of the need for more scanning of shipments at airport, ports and borders generally.
■ Move to reintroduce border controls in some countries and regions.
Arnab Basu, chief executive of Kromek, believes this is a significant, long-term contract in the security screening market for his company. I agree as it continues a trend of multi-year contracts Kromek has been signing as customers move away from legacy systems and embrace CZT detection technology.
Moreover, the security screening contract de-risks analysts’ estimates for the financial year to end April 2019. Analysts at both Cantor Fitzgerald and Equity Development predict that Kromek is on track to lift annual revenues by more than a quarter to £15m and more than treble underlying cash profits to £1.65m. The growing contract momentum also de-risks expectations of cash profits almost doubling to £3.1m on revenues of £18.8m in the 2019/20 financial year.
It’s worth noting that analysts forecasts don’t factor in the blue sky opportunity Kromek has with its ‘dirty bomb’ detectors (10 times faster at detecting gamma and neutron radiation, and at a tenth of the cost of conventional detectors) which could be rolled out across 20-plus cities in the US if Kromek secures a slice of an $8.2bn US government contract. Each city contract could be worth $10m in revenue alone to Kromek, highlighting the substantial profit potential. The company’s technology is already proving popular with the US Department of Homeland Security (to develop CZT detector modules for commercial off-the-shelf detectors for advanced X-ray systems in passenger baggage screening), and the Defence Threat Reduction Agency (for the development of the next generation of handheld nuclear radiation detectors).
In medical imaging, Kromek’s patented CZT-based radiation detection technologies are already used by 11 OEM customers across single photon emission computed tomography (SPECT), BMD (to treat osteoporosis) and gamma probes (used for radio-guided surgery). The detectors are capable of diagnosing and monitoring conditions like Parkinson’s disease and making early diagnosis of cancer too. That’s worth noting if major OEM competitors to market leader GE Healthcare (which has been stealing a march on its rivals) decide to contract Kromek as a CZT supplier for their own CZT-SPECT medical imaging cameras. Kromek is one of the few independent, end-to-end CZT manufacturers with the required design, engineering and technological skills to produce sufficient commercial quantities of the material, and has capacity to scale up production from its state-of-the-art facility in Pittsburgh, Pennsylvania.
The point being that net of a £7.7m cash pile on Kromek’s balance sheet, the company’s enterprise value of £57m equates to 18 times cash profit estimates for the 2019/20 financial year. If a major medical imaging, dirty bomb detector or security baggage screening contract is landed, as I suspect it will be, then that multiple will fall sharply given that Kromek is highly operationally geared so an increasing proportion of incremental sales drop to the bottom line. I would also flag up that well over half of Kromek’s sales are in US dollars, a point worth noting in light of ongoing sterling weakness so there is a positive translational currency tailwind on the company’s international sales. Since the start of Kromek’s 2019/20 financial year in April, sterling has fallen by 11 per cent from £1:US$1.44 to £1:US$1.28, thus making US sales far more valuable.
So, although Kromek’s shares are unchanged on the 25p level at which I initiated coverage ('Follow the smart money', 27 Feb 2017), albeit the share subsequently hit 37p before profit-taking took hold, and have moved sideways since the company last announced a spate of contract wins when I last covered the investment case (‘Kromek’s contracts building up’, 20 August 2018), I maintain the view that a return to those share price highs is a distinct possibility if the contract momentum continues to build. Buy.
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