Annual results from Aim-traded IXICO (IXI:68p), a London-based company that uses proprietary artificial intelligence (AI) software algorithms to analyse images from brain scans were materially better than I had anticipated when I recommended buying the shares, at 33p, in the summer ('Alpha Report: Simon Thompson spies opportunity in cutting edge technology', 23 July 2019). Having upgraded his earnings forecasts twice since then, analyst Chris Donnellan at house broker Cenkos Securities has done so again on the back of the latest results, highlighting the ongoing strong momentum in the business.
The scans – magnetic resonance imaging (MRI) and positron emission tomography (PET) – provide measurements of small changes in brain structure, assess the efficacy of new drugs being trialled, monitor patient safety, and provide valuable insights on different aspects of trial performance. Outsourcing the work to clinical research organisations is proving popular with the world’s largest biopharmaceutical companies that are investing huge sums of money in the field of neurology to target therapies for diseases affecting the central nervous system including Huntington’s, Alzheimer’s and Parkinson’s disease.
IXICO reported record annual revenue of £7.6m, up 40 per cent year-on-year, and it’s high value work as gross margins were 6.6 percentage points higher at 65.4 per cent. This meant that gross profit, up 55 per cent to £5m, increased at a faster rate than revenue. So, with a relatively fixed cost base – operating expenses only increased by 14 per cent – IXICO has passed the inflexion point whereby an increasing proportion of gross margin earned from incremental revenue is converted into profit. To put the operational gearing of the business into perspective, IXICO’s operating loss of £0.8m on revenue of £5.4m in 2018 turned into an operating profit of £364,000 on revenue of £7.6m in the 12 months to 30 September 2019. Cenkos had predicted a maiden operating profit of £50,000, so this was a major earnings beat.
Moreover, because gross margins are higher than Cenkos had anticipated, and operating costs lower, the broking firm has been forced to upgrade its operating profit estimates by a thumping 70 per cent to £508,000 for the 2019/20 financial year, and by 10 per cent to £1.04m the year after. Forecasts are based on annual revenue rising by 20 per cent to £9m and £10.8m, respectively. However, even the upgraded estimates could prove conservative given that IXICO has increased revenue at a compound annual growth rate of 35 per cent over the past three financial years and continues to win new contracts ('Profiting from artificial intelligence', 28 October 2019).
Indeed, the closing order book of £15.9m equates to 80 per cent of the combined revenue forecast for the next two financial years, thus providing a high level of visibility and materially de-risking earnings estimates. IXICO has announced five notable contract wins since August, all of which highlight the value of its core technology and ability to unlock insights on a broad range of neurological disorders and across the full spectrum of clinical development.
Interestingly, one of the contracts is focused on a progressive supranuclear palsy (PSP) programme for a new client, ahead of patient enrolment. The 12-month contract, worth £400,000, is expected to lead to a larger programme of work in early 2020, highlighting how the expansion of its services into new therapeutic markets. Another new contract involves a study with an existing client that will see IXICO’s AI technology extended and deployed to several sites in mainland China.
Importantly, the company is well funded to maintain its growth trajectory, ending the 2019 financial year with net funds of £7.26m (15.5p a share), a sum equating to 25 per cent of IXICO’s market capitalisation of £31.2m. Strip out net funds, and the company’s enterprise value of £24m equates to 25 times net profit estimates of £947,000 for the 2020/21 financial year. However, if as seems likely IXICO continues to win new contracts, then analysts will be forced again to push through yet more earnings upgrades so that multiple is likely to drop sharply in due course. Buy.
Please note I will now be on annual leave until Monday, 6 January.
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