80. Avacta Group
Around 70 per cent of drugs make it through phase I trials, according to US Food and Drug Administration (FDA) estimates – but only 33 per cent make the leap from phase II to phase III. This makes a company counting on the success of a first-stage drug look like a bit of a risky prospect.
At present, Avacta’s (AVCT) lead therapeutic asset is a cancer drug called AVA6000, which is in ongoing phase I trials for the treatment of a rare cancer called soft tissue sarcoma. The medicine recently received “orphan drug designation” from the FDA, which qualifies its developer for certain incentives, including seven years of market exclusivity upon regulatory approval.
In other words, the treatment will enjoy significant commercial advantages if it makes it through the rigorous trial process. Successfully demonstrating proof-of-concept “would lead to a portfolio of similarly acting” oncology products, according to analysts at equity research firm Trinity Delta. Good trial results would also be seen as a vote of confidence in Avacta’s Precision technology platform, which improves the potency and reduces the toxicity of cancer drugs by activating them inside tumours only.
Avacta’s business is split into two divisions – therapeutics and diagnostics. The former contributed £5.4mn of the £5.5mn in revenues recorded in the first half of 2022, derived in part from milestone payments by research partners. The diagnostics arm is currently focused on expanding its pipeline of new products following the successful rollout of its Covid-19 home tests. Early this year, the company decided to pause sales of its AffiDX antigen test, which was not as effective at detecting the omicron variant. Redevelopment of the product is ongoing.
At the halfway point this year, Avacta had £17mn in net cash and short-term deposits, a year-on-year drop of almost £20mn. It had more than £26mn in cash at the end of the last calendar year. Outflows in the first half were attributed to operations and working capital movements, as well as investing activities.
In its interim results, Avacta’s board said it believes that a “significant” near-term value driver for the company is the forthcoming clinical data from the phase I AVA6000 trial. First-look data is expected in the fourth quarter of 2022. Interested investors would be wise to wait on its release. Hold. JJ
79. IQE
Sectors across the board have been hampered by a semiconductor shortage that stretches back nearly two years. Ostensibly, this should provide a favourable trading background for IQE (IQE), a Cardiff-based producer of wafer products to the industry and the operator of an advanced epitaxy foundry that produces a crystalline material used in high-end semiconductors.
The company has been lossmaking since 2019, a period in which supply chain issues were already to the fore, and the rollout of 5G infrastructure stuttered. The epitaxy materials are used extensively in semiconductors destined for the photonics and microelectronics markets. Unfortunately, demand within the former sector has been stymied by the pandemic-linked slowdown in the global aerospace industry, while sales volumes for the latter have now begun to slow due to wider macroeconomic anxieties.
Newly announced development and commercialisation arrangements with both Belgium’s MICLEDI Microdisplays and South Korea’s SK Siltron, a supplier to Samsung, point to the importance – indeed centrality – of advanced material applications in the rush towards digitalisation. However, given the unavoidable research and development imperatives involved, investors would be justified in pondering on questions of scale where companies such as IQE are concerned. Hold. MR
78. i3 Energy
The share price of i3 Energy (I3E) has surged over the past 12 months, a partial reflection of improved prospects for oil and gas production in the United Kingdom Continental Shelf (UKCS). Unfortunately, a relative minnow with half-a-dozen interests stretching between Canada and the North Sea will always be subject to market volatility, as evidenced by a pullback in its valuation earlier this month following disappointing drilling results from its Serenity appraisal well in the North Sea.
Prior to that, the driller’s interim figures through to the end of June revealed a near-fourfold increase in revenue to £102mn, accompanied by a 22.5 percentage point increase in the gross margin despite substantial loss increases in respect of risk management contracts and depletion charges. On the latter point, the ongoing realised average decline rate stands at 11.5 per cent, on 60mn developed and producing oil-equivalent barrels (boe) and 154mn boe of proven and probable reserves. Average daily production doubled from the 2021 half-year to 18,950 boe, and with more than 450 net drilling locations identified, i3 could expand reserves and production levels significantly over time.
The company closed out the half-year with a net cash position of £4.8mn, although decommissioning provisions were weighing on net assets to the tune of £95mn. Nonetheless, medium-term commercial prospects are supported by limited spare oil and gas production capacity worldwide. Hold. MR
77. Lok’n Store
The self-storage business has been going strong for years. The model thrives on the counter-cyclical demand for space to store items, generated by disruption. And if there is one thing the past few years have had in spades, it’s disruption.
The next phase of upheaval may look slightly different: housing market transactions could slow down, but price pressures for both owners and renters should support the investment case. The big question then is how much is too much to pay for a company such as Lok'n Store (LOK).
The all-time high 1,090p from April this year was arguably excessive. And even after falling to below 750p thanks to the market uncertainty caused by the government’s mini-Budget, the company still looks pricey at 25 times next year’s consensus earnings. However, quality comes at a price, and the counter-argument is that, on current trends, Lok’N’Store may soon be trading at a discount to book value. Interim results are due on 31 October, but this implies there is an opportunity for investors to ‘buy the dip’. Buy. ML
76. Idox
Idox (IDOX) sells software to local councils to help manage everything from elections to planning control. In short, it brings disparate information together onto the same platform. In the six months to June, the public sector accounted for 89 per cent of the total revenue.
Increased sales to these clients pushed up overall revenues by 7 per cent. The government doesn’t often pay well: the operating margin was just 13 per cent. However, they do at least pay promptly, which explains the impressive cash conversion of 122 per cent.
The investment case relies on the need for digital transformation across all levels of the public sector. The government itself made the case for this in last autumn’s Budget. But things have changed since under a new chancellor and prime minister. Purse strings are now tightening in response to the recent bond crisis.
Most high-quality software companies have a combined operating margin and growth rate of around 40 per cent. Idox is well below this and the consensus forward PE ratio of 22 looks a little expensive for our liking. Sell. AS
75. Elixirr International
Consultancy firm Elixirr International (ELIX) ventured onto Aim in July 2020. Since then, its share price has tripled, sales have jumped by almost 150 per cent and it has introduced a dividend. The newcomer must be doing something right.
The company takes a frank approach: its marketing explicitly acknowledges the scepticism many have about the value of consultancies. It is building a robust customer base, and expects a growing number of clients to generate in excess of £1mn in revenues by the year-end. Client retention levels also look strong – in 2021 the business had more than 200 clients, having added 80 in the year, yet half of customers had nonetheless used Elixirr’s services before.
The group is not infallible, however, and margins are coming under pressure. In the six months to 30 June 2022, cost of sales jumped by 48 per cent on the back of a 39 per cent revenue rise. Management blamed this on additional travel and business development costs, which were largely absent in the unusual lockdown environment of 2021.
The big question is whether companies will still seek out expensive consultants as the economy deteriorates. The performance of the sector amid the recession of 2008-09 suggests fees might take a hit. Hold. JS
74 Strix
Demand for shares in kettle controls maker Strix (KETL) has come off the boil – after peaking at 390p in September last year, they now trade at just above 100p.
Downbeat interim results showing a 12 per cent decline in pre-tax profit didn’t help, nor did chief executive Mark Bartlett’s comment that macro headwinds were reducing demand for its products. It also recently launched a discounted share placing to help pay for Billi – a provider of mixed taps that supply instant boiling, chilled and sparkling water systems.
Billi is being sold off by its parent company to allay competition concerns surrounding a bigger industry merger, and the price being paid looks decent – £38mn for businesses in Australia and New Zealand that made a cash profit of £6.9mn last year and a UK arm expected to generate £10.2mn this year. Strix’s de-rating also means its shares are now valued at seven times earnings, but given the shaky macro outlet we maintain our hold recommendation. MF
73. Gresham House
Gresham House (GHE) is an under-the-radar specialist asset manager, but as of 30 June it had £7.3bn of assets under management – not inconsequential. The firm specialises in alternative and ESG assets and currently owns large swaths of Ireland via the purchase of the Burlington Property estate, as well as forests in New Zealand and alternative power projects. The main selling point for Gresham is that these types of assets mean it has relatively little exposure to public markets, alongside the closed-end nature of its funds. This has lent the shares a greater resilience this year, compared with its sector peers, which has allowed them to limit losses by comparison.
Management is confident that operating profits will at least match market expectations, which means around £26mn for the full year, according to analysts at broker Panmure Gordon. Overall, Gresham House is an interesting proposition for investors who want to diversify their holdings of asset managers, although the note of caution is that the company’s investments are relatively illiquid. Buy. JH
72. Atalaya Mining
There are two related but opposite forces at play when it comes to Atalaya Mining (ATYM): as a European copper miner, its costs are much higher than the competition in South America, but it also offers a proximity to European buyers that hugely cuts down the carbon footprint of the end product, and usually can manage a stable operating environment.
Atalaya’s Riotinto mine in Spain is its key operation, and conditions have worsened considerably this year because of power prices, although government intervention has helped. Operating costs in the June quarter climbed almost two-thirds on the year before, to €79mn (£69mn), which combined with lower copper prices sent the quarter’s cash profit down 72 per cent to €15mn. Each €100 per megawatt-hour change in the power price adds €37mn in annual operating costs.
One positive is last year’s establishment of a dividend, after a legal roadblock was cleared. That, combined with the long-term bull case for copper, is enough for us to recommend buying in despite the current operating environment. Buy. AH
71. Life Science Reit
How deep is the demand for laboratory space in the UK? That is the question central to Life Science Reit’s (LABS) investment case.
The trust listed in November last year as the only UK-listed property group focused on the country’s life-science sector. At the time, with investor appetite for anything property or science-related sky-high, the company was able to raise its initial fundraising target from £300mn to £350mn after a surge in demand for the shares. A year on, and following a mini-Budget-sparked property sell-off, LABS shares sit 30 per cent below their IPO price. Some of this selling feels justified. In less than a year, the blended interest rate on the group’s debt facility is up from 2.7 to 4.4 per cent, and on course to hit 7.3 per cent by next summer, should the BoE’s headline rate hit 5 per cent. A fifth of the portfolio is also un-let.
What’s more, a looming recession is likely to hurt demand for additional space from precisely the sort of international science giants and life-science start-ups the Reit depends on. All of which is concerning when the shares are priced at 25 times the Factset-compiled consensus earnings forecast for 2023. However, despite these particularly dark clouds, there are several bull points for this Reit. First, spare use of that borrowing facility to date means the company’s loan-to-value only stood at 9.5 per cent at the end of June – providing the young Reit with breathing space should the economic environment deteriorate further.
Second, while its vacancy rate might sound high, the Reit is only a year old. Given more time in a market where Savills (SVS) calculates there is 2.9mn square feet of demand for space in Oxford and Cambridge alone and scarce supply, its labs will soon be let. The trust’s managers told us they expect the portfolio will be close to fully let by the end of next year, because it is solving a structural lack of supply rather than a cyclical one. Throw in LABS’ 30 per cent discount to NAV and this share starts to look pretty cheap.
In short, for every argument highlighting the trust’s rental and asset growth potential, investors need to be mindful of the constraints. On balance, a wait-and-see approach to the shares seems sensible. Hold. ML
