James Faulkner on WatsHot in the small cap markets: Clinigen, Xaar and Utilitywise

Clinigen (CLIN)

Having recently covered Clinigen in our August issue as a pick for H2 2014, I thought it worth updating on recent news at the company.

Last week Clinigen announced the acquisition of the global rights to the oncology support therapy, Ethyol (amifostine) from AstraZeneca. Ethyol is a cytoprotective (cell protecting) drug indicated as an adjuvant therapy (i.e. one that modifies the effects of other agents) to reduce the incidence of xerostomia (dry mouth) as a side-effect in patients undergoing post-operative radiation treatment for head and neck cancer. It also reduces the cumulative renal (kidney) toxicity associated with the repeated administration of cisplatin in patients with advanced ovarian cancer. In 2013, Ethyol revenue was approximately $4.9 million.

Under the terms of the agreement, Clinigen will assume full responsibility for the distribution of the product with immediate effect. AstraZeneca, working closely with Clinigen, will continue to manufacture the product whilst the NDA and Investigational New Drug (IND) authorisations are transferred and the technical transfer to a third party manufacturer is completed. The acquisition will be paid for in milestone related stage payments linked to the transfer of manufacturing. The financial terms of the agreement were not disclosed.

It is encouraging to see Clinigen continue to reduce its reliance on its flagship Foscavir product, especially given the recent weakness seen in this area. Ethyol is the second product Clinigen has acquired from AstraZeneca (the first being the anti-viral Foscavir in 2010), and the group’s third oncology support product adding to Cardioxane and Savene bringing the Specialty Pharmaceuticals portfolio to five products in total. 

Indeed, Clinigen has a strong track record in this regard.

Clinigen acquired Foscavir for £9.15 million – a price to sales ratio of 2 times – from AstraZeneca in early 2010. Through its local knowledge and global reach the firm has successfully increased pricing around threefold in most countries, has sought (and started to receive) additional regulatory approvals, and is broadening the product’s geographic footprint. Sales have grown rapidly from £4.6 million in 2009 to £21.7 million in FY2012.

With Ethyol, Management is targeting doubling of revenues in 3 years, which appears reasonable given the attractive synergies on offer with Clinigen’s existing oncology portfolio. Broker N+1 Singer left its EPS forecast for FY15 unchanged at 24.1p, but raised its FY16 forecast by c.8% to 29.9p.

I retain my view that Clinigen has a unique combination of businesses that delivers a whole greater than the sum of the parts, which sets it in good stead to realise its ambition of becoming the number one global provider of CTS and GAP services and a major global specialty pharmaceutical company. Furthermore, the cash generative nature of the business means that acquisitions, for the most part, should be able to be funded internally from cashflow. Interestingly, should Clinigen not undertake any further acquisitions, Singer anticipates a net cash position of £38.7 million by June 2016.

Meanwhile, house broker Numis has noted the potential for “over 100% upside to its 5-year forecasts”, should the company meet its stated ambition to become the market leader in both CTS and GAP through organic growth, and to add a further 5-7 specialty pharmaceutical (SP) products over the next 3-5 years (it has added two since the Numis note was published).

In this context, I believe the current rating of c.16.5 times 2015 consensus forecast earnings looks like good value, especially when one factors in the rapid earnings growth anticipated over the foreseeable future (PEG <1). The shares have performed well since the August issue of Spread Bet Mag, but there appears to be more to play for here.

Xaar (XAR)

I flagged this one back in June as potentially approaching value territory, but the shares put in another hefty drop last week on the back of another profits warning. In fact, the decline from the peak of 1,162p, reached at the end of 2013, has been somewhere in the order of 63%, which highlights just how overvalued these shares had become. As I wrote back in June:

“To be frank, the rating of the shares prior to the crash was far to high for a company which constantly has to strive to stay one step ahead of the competition. Trading at Xaar has followed a regular pattern whereby the firm introduces a new technology and makes lots of profits, competitors eventually copy it, margins get eroded, a new technology is introduced ad infinitum…”

So what’s the story behind the further c.20% fall? Well, both turnover and profits were down during the first half of 2014, mainly on the back of stiffer competition and some market softening. In light of this, the board’s expectation for 2014 revenue has reduced to £115-125 million, with adjusted operating margin projected to be broadly in line with the 26% achieved in the first half of the year. Profit warnings usually come in threes, according to the old adage, so I wouldn’t be surprised to see Xaar scale back near-term guidance again, perhaps later in the year.

But for me, the near-term outlook isn’t the real story – and those who focus on it appear just as short-sighted as those that focused on the one-off explosion of profits in 2013. If the market can get it so wrong in one direction, it can do the same in the opposite direction. What should be piquing the interest of long-term investors is the product development pipeline, which is looking very strong indeed. As the company explains,

“We remain entirely focused on our market of industrial and commercial inkjet. This will always be technologically and operationally challenging, and that of course provides a significant barrier to entry. Our considerable experience can only help Xaar remain a leader in this market that offers enormous potential. To capitalise on that we must continue to develop technology and products that can successfully convert printing applications from analogue to digital processes. 

We continue to lead the market in ceramic tile decoration and remain excited by the future potential offered by tile decoration and a number of other ceramic tile processes. In addition, our partners continue to develop solutions with our technology across multiple applications in both the packaging and industrial markets. As highlighted in June, pre-production activities within the ‘Direct-to-Shape’ application continue, and our expectations of this opportunity for the longer term have strengthened. Despite being long lived, Grand and Wide Format Graphics remains an opportunity and we are targeting to regain share. Our Thin Film Programme, we believe, will open up multiple further markets to Xaar, significantly broadening the total opportunity over the long term.”

Recent success has been generated principally through tapping the ceramic printing market, so myriad opportunities remain open to Xaar. With significant operational gearing in the business, I would not be surprised to see profitability explode once again a few years down the line.

For the time being, there is a 2% dividend yield on offer and the balance sheet looks squeaky clean with a sizeable net cash position of c.£48 million. There’s also the potential for one of Xaar’s many competitors to take advantage of the share price and make a swoop for the company to steel a march on rivals.

Utilitywise (UTW)

Shares in Utilitywise have seen some weakness since I first covered them here back in May, but the growth case is as good as ever. In a brief trading update earlier this month covering the year ended 31st July 2014, Utilitywise confirmed that revenue and adjusted profit before tax is expected to be in line with market expectations. Net cash balances at 31st July 2014 stood at approximately £9.7 million, comfortably ahead of market expectations, in part as a result of improved commercial terms with a number of energy suppliers. The group’s revenue pipeline, representing revenue secured but yet to be recognised, was £28.2 million as at 31st July 2014 compared to £16.6 million as at 31st July 2013 (and up from £23.8 million as at 31st January 2014). The current pipeline represents 45% of broker finnCap’s full-year revenue forecast, up from 35% 12 months ago.

Current trading was said to be strong, and organic growth is underpinned by the planned move to the new facility (on schedule for occupancy to commence in October) which will provide the necessary capacity to grow total headcount to 1,400 over the next two years. The customer base continues to grow across all business units and the group’s new business run rate remains in line with management expectations. Meanwhile, following its acquisition in April, ICON is performing as planned.

Even when excluding international expansion from its model, broker finnCap believes that Utilitywise has the potential to almost double profitability over a two-year period from the end of the financial year just ended. For the year just ended the broker forecasts an adjusted pre-tax profit of £13 million giving EPS of 12.6p. In 2015 it sees an adjusted profit before tax of £18 million, implying adjusted EPS of 18.2p. It also recently introduced a 2016 forecast for the first time to reflect the early benefit of the further scaling, implying a move to an adjusted profit before tax of £25 million and EPS of 25.4p.

On these forecasts, Utilitywise shares trade on a P/E multiple of 22.6 times (year ended July), falling to 15.7 times for FY15 and to 11.2 times for FY16. This is against forecast EPS growth of 48.1%, 44.5% and 39.8% respectively. These metrics continue to look attractive for a highly scalable business growing as quickly as Utilitywise, especially given the opportunity for a further uplift to these numbers from European expansion. The continued growth and evolution of the group into a one-stop-shop for businesses’ utility management and consultancy needs represents a compelling investment opportunity.