Analysts think this stock's share price will quadruple

Sedgefield-based Kromek (KMK:6.85p), a radiation detection technology company focused on the medical imaging and nuclear markets, has announced a company-transforming seven-year agreement with a top-tier original equipment manufacturer (OEM) to develop cadmium zinc telluride (CZT)-based detectors for the client’s advanced medical imaging scanners.

Following a short development period, the agreement will transition into a longer commercial supply phase. The enhanced image quality associated with the technology could enable the earlier detection of diseases, such as heart disease and cancer, thereby improving patient outcomes and increasing efficiencies within healthcare settings.

Analysts at Equity Development note that the medical imaging market is divided between computed tomography (CT) and single-photon emission CT (SPECT)-based products and is dominated by four tier-one suppliers: Phillips Medical Systems, Siemens Healthineers GmbH, Canon Medical Systems and GE Healthcare.

House broker FinnCap estimates that the CT medical imaging scanner market was worth $6.7bn in 2022, with the tier-one suppliers controlling 85 to 90 per cent of the market. Market research company Market Data Forecast estimates that the CT scanner market could be worth $7.2bn in 2023, growing to $9bn by 2028, the implication being that this could be a $10bn market by 2030.

Value of agreement to Kromek

On this basis, FinnCap calculates that the CZT-based share of the CT scanner market could be worth $2bn in 2030, assuming the new technology scanners take a 20 per cent share of the total market, suggesting an addressable market opportunity of $300mn-$400mn for a tier-one supplier. This would imply revenue to Kromek of $64mn (£51mn) in 2030, generating $26mn (£20mn) of gross profit on a margin of 40 per cent and annual cash profit of £10mn-£15mn.

Moreover, assuming the tier-one OEM converts 50 per cent of its scanners to CZT over a 10-year period, it implies that the agreement has a net present value (NPV) of £39mn-£59mn (9p to 14p a share) using discount rates of 10 to 15 per cent, respectively. In a more optimistic scenario in which the conversion rate rises to 75 per cent, the NPV of the agreement rises to £58mn-£87mn (13p to 20p a share), a hefty sum in relation to Kromek’s current market capitalisation of £28.8mn (6.85p).

The strategic value of CZT to tier-one OEMs in their next-generation diagnostic imaging development was brought into sharp focus in September 2021 when Canon acquired Kromek’s rival Redlen Technologies for a valuation of $290mn, or a multiple of 20 to 33 times its annual revenue (£5.mn to £8.4mn) at the time. Kromek is now the only independent developer and producer of CZT-based detection systems. Equity Development has a read-across implied valuation for Kromek’s medical imaging division of £247mn (57p), or 8.5 times its current market capitalisation, based on a multiple of 25 times 2023-24 revenue estimates of £9.9mn for the unit.

Potential for more contract wins

Analysts expect Kromek to win additional customers looking for CZT detection solutions in both CT and SPECT, given the technology’s superior sensitivity, higher energy resolution and better imaging contract performance capabilities.

Equity Development notes that second-tier suppliers include Spectrum Dynamics, United Imaging, Analogic Corporation, Fuji Film Medical Systems, Mars, Mediso, NeuroLogica and Samsung, which each control a single-digit market share of the CT medical imaging market. FinnCap believes that in aggregate second-tier suppliers have a current market share of $800mn to $1bn of the CT medical imaging market, implying an addressable market for CZT of up to $200mn in their base case scenario.

Furthermore, Kromek has announced an agreement with one of the second-tier suppliers, Analogic Corporation, to collaborate on the development of next-generation CZT-based detector solutions for photon counting computed tomography (PCCT) applications in the medical imaging and security sectors.

CZT-based PCCT detectors overcome limitations inherent in conventional CT detectors to deliver improvements in spatial resolution, radiation dose reduction and energy resolution. The technology can improve image quality while providing quantitative results for early detection of life-threatening illnesses such as breast cancer when used in medical imaging. In security screening, the improved image quality and 3D images of passenger bags and parcels will allow passengers to keep luggage in their bag while accurately identifying prohibited and dangerous items in real-time.

As part of the collaboration, Kromek will integrate CZT sensors with Analogic's detector designs to ensure optimal detection system performance. 

Positive pre-close trading update

Kromek’s shareholders can also be reassured by a trading update that confirmed growing momentum in the second half from multi-year contracts.

Third-quarter revenue was 50 per cent higher year on year, group margin is improving (high-40s percentile forecast) due to changes in the product mix sold, and Kromek is expected to report a cash profit in the second half of the financial year to 30 April 2023. Importantly, the business was cash neutral in the third quarter and is expected to remain so through the fourth quarter, too.

So, although Kromek is still expected to report a cash loss of around £2.2mn on revenue of £18mn in the 12 months to 30 April 2023, both Equity Development and FinnCap predict a cash profit in the new financial year of £0.9mn to £1mn, respectively, on revenue of £21mn. Analysts have fair valuations of 26p to 27p, although Equity Development’s sum-of-the-parts valuation of 67p is more than double that.

Admittedly, Kromek’s share price has trended down since I last rated the shares a hold (‘This stock is about to turn world-leading technology into profit’, 6 February 2023), but I feel that the foundations are in place for a decent re-rating. Ahead of the annual results in July, I rate the shares a recovery buy.

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