REACT Group – a ‘penny stock’ that could easily double in price

Mark Watson-Mitchell feels that shares in REACT Group are capable of doubling and more besides.

Looking at as many smaller quoted companies as I do, it is good to have found a really small one that is actually doing well during the pandemic situation.

If you don’t have time for tiddlers then switch off right now.

This one is only capitalised at £7.5m.

However, it currently has about £1.8m of cash, is likely to make about £500,000 pre-tax this year and, wait for it, it has a build-up of annual recurring revenue.

Regular readers of my profiles will know by now just how much how I love to see ARR.

Lovely annual recurring revenue

To any company boss and/or finance director ARR is a combination of three magic words. 

Annual recurring revenue is the portion of a company’s revenue that is expected to continue in the future. Such revenues can be regularly received and used in forward budgeting of any future expenditure.

And this little company has two areas of its business generating 80% of its revenues and kicking in some 74% of its gross profits.

But I am running ahead of myself here

On Tuesday of this week REACT Group (LON:REAT) announced its final results for the year to end-September 2020.

Last year its sales improved 41% to £4.36m, upon which it showed a 64% improvement in gross profit to £1.45m, operating on an increased gross profit margin of 33.2% (28.5%). From a previous loss of £183,000 the company swung round to make a £188,000 pre-tax profit.

Quite a milestone

They showed a maiden profit for the company, which despite its size is a leader in the specialist cleaning, hygiene, and decontamination sector.

Its core business includes regular deep cleaning regimes in the health service, on parts of the rail network and the highways, emergency call-out work to respond to trauma, anti-social behaviour, and other hazardous incidents across a range of sectors.

That includes working for some of the industry’s largest facilities management firms, through to specialist ad hoc work such as dealing with void clearances, fly tipping, pigeon guano clearance, and graffiti.

Three main parts of the business

The group has three main areas of business, the first two are Contract Maintenance, where it delivers regular deep cleaning regimes, such as in the healthcare and public transport sectors, operating on between one to five-year contracts; and Contract Reactive, where it is the first responder to an on-call emergency response service operating under a formal contract or framework agreement, which is typically 24-hours a day, 7-days per week, 365-days of the year.  

The third area is Ad Hoc, where the group provides a solution to typically one-off situations outside a framework agreement, such as for COVID-19 decontaminations. 

Quality, reach and range

The group considers that its purpose is to rapidly return its customers’ property to safe, clean, operational use and do this through regular specialist cleaning and/or emergency response to potentially harmful incidents. 

As a genuine specialist, it operates in a fragmented market where quality, geographical reach and range of service is a challenge. 

The company is one of the very few specialists with full coverage of the UK, operating to a call-out time of less than four hours. 

Such service is essential for its larger customers that rely on a consistently high-quality standard and upon an urgent response to provide their own customers with minimum interruption of service. 

Value in its work creates regular business

The work its specialists undertake has tangible value. The cost of not being able to operate a train, open a hospital ward or occupy property can be quite material. That means that the company’s work is valued and why it operates at higher margins than for regular cleaning. 

Its customers value both its quality and its speed of response. It is apparent that they recognise the company as one of the very few specialists to deliver such strength and diverse capability across the whole of the country. 

Growing revenues

The company has already identified that its strategy is to continuously improve the financial model, growing revenues whilst maintaining strong margins by delivering valued services, at the same time as improving the long-term recurring nature of the group’s income.

There it is again – recurring revenue – it almost gives me a thrill to see it in print. 

Just ask any boss – do you prefer one-off business or sales that keep on repeating and repeating, where you can increase margins by improving the service being offered.

Small in size but big in aspirations

I told you this company is small, but I believe that it is now ready to really grow in size.

Executive Chairman Mark Braund states that “our strategy for growth is clear; we will continue to build a leading position across our business through fast paced organic growth and if the right opportunities present themselves, via strategic acquisitions, to support our goal of becoming the country’s most trusted name in the provision of specialist cleaning, decontamination, and hygiene services.”

A fairly tight equity

There are some 498.5m shares in issue.

Large holders include Octopus Investments Nominees Limited (17.14%), Helium Rising Stars Fund (16.17%), Premier Miton (8.10%), HSDL Nominees (6.24%), Mr J Whitmore (5.29%), HSBC Global Custody (4.01%), The Bank of New York (Nominees) (3.93%), Lawshare Nominees (3.64%), Mr G Stavrinidis (3.32%), HSBC Global Custody (UK) (3.23%), Hargreaves Lansdown (3.54%), Nortrust Nominees (3.22%), and Interactive Investor (3.03%).

Broker estimates 268% rise in current year profits

Analyst Ian Jermin at Allenby Capital is cautiously looking for the group this year to end-September to increase sales to £5.16m, upon which it could make £505,000 pre-tax profits, worth 0.10p per share in earnings. He sees net cash rising to £2m by the end of the year.

These shares could double and still hold potential

A year ago, the group’s shares were trading at just 0.55p, they peaked at 1.75p in May last year, then just two months ago they were easier at 0.95p. They have subsequently been edging forward to the current 1.5p.

Based on what I can see about this very small-cap company I feel that its shares are capable of doubling and still then offering upside growth possibilities. 

It is almost at the start of its real expansion and as such I now put the shares out on a 2.5p target price.