AIM has had a shocking 2022 but will recover

AIM is currently the world’s worst performing index this year. Award-winning AIM expert Andrew Hore explains why, and also how the small-cap index can get back on a growth trajectory.

AIM is the worst performing major market in the world this year. Only Brazil and India have risen, but the declines in other markets, although many are significant, are not as great as for the junior market in London.

The 29% decline in AIM is even worse than the fall of around one-quarter for Nasdaq, while the FTSE 100 index has sharply outperformed AIM with a modest 1.5% decline – although the FTSE 250 index has fallen by one-fifth. The FTSE AIM 100 index has fallen even further than AIM as a whole, with a decline of more than 31%. That is because of sharp falls in some of the largest constituents. 

Even the FTSE China 50 index has outperformed AIM with a 23% decline. The FTSE All-World index – Europe excluding UK has fallen by slightly more than AIM. France, Switzerland and Germany have the highest weightings in this index, accounting for nearly three-fifths. It includes big companies such as Nestle.

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Historically, small companies tend to recover after the more secure larger companies. Investors want a safer haven for their money in times of uncertainty and pick out what they believe are more reliable companies. However, this did not happen after March 2020, when AIM significantly outperformed the Main Market.

The outperformance by the FTSE 100 is partly catching up with the previous gains by AIM since the pandemic lows. AIM reached the bottom on 19 March 2020 and has risen by 46.2% since then, while the FTSE 100 index has risen by 41% over the same period.

The significant weighting of oil and gas companies, such as Shell (LSE:SHEL) and BP (LSE:BP.), and banks, including Standard Chartered (LSE:STAN) and HSBC Holdings (LSE:HSBA), has helped with the recent stronger performance of the FTSE 100. In contrast, technology and biotech companies have a larger weighting on AIM and they have not performed as well.

The AIM bubble burst

Many AIM share prices had got ahead of themselves by the end of 2020. That is particularly true of biotech and technology companies. Kidney disease transplant management and care provider Renalytix (LSE:RENX) was one of the best AIM performers in the 2020 and early 2021, but the share price has fallen below its initial level in 2019 when it was spun out of EKF Diagnostics Holdings (LSE:EKF). Renalytix is also traded on Nasdaq.

Following the resignation of its boss electrolysers developer ITM Power (LSE:ITM) is one of the poorest performers of the larger AIM companies. This is in sharp contrast to the recent past. It had become one of the largest companies on AIM in early 2021, but the share price has slumped. It is still higher than at the beginning of 2020.

These companies do not currently have any earnings or other measures to underpin their share prices and that is why they have fallen back so sharply.

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Using annual numbers can mask what is going on, but they provide a simple measure (see table below).

Generally, AIM has outperformed the FTSE 100 index after it has underperformed. This is particularly true when there has been a sharp correction.

2009 is the most obvious example with a bounce back in 2010 followed by further sharp outperformance the following year. Outperformance in other years is less pronounced, but one or two years of underperformance tend to be followed by outperformance.

AIM will recover

There will be a recovery in AIM and, in the short term, it is more likely to come from companies with revenues and profit that will hold up relatively well in uncertain times. The economic uncertainty could continue to hold back AIM, but this is the time when smarter investors will be seeking out value.

Many investors jump on the bandwagon when share prices have already increased. They are reassured by the recovery, but they may have missed most of the uplift. When things are still bad it is a good time to at least try to identify attractive potential long-term investments.

The significant underperformance this year does reflect a rebalancing of AIM company valuations, but the extent of the decline means that some attractive opportunities are starting to appear.

One thing to notice is that some of the solid larger AIM companies are attracting bids from private equity. Healthcare IT provider EMIS Group (LSE:EMIS) had performed relatively well, although it was below its high, when it recommended a bid at a significant premium.

The latest approach is for identification services provider GB Group (LSE:GBG) from GTCR LLC. There is no indication of possible terms or valuation. The share price reaction has not taken it back anywhere near to its previous peak in 2021 – it is currently less than two-thirds of that level – but it is much higher than before the bid. GB Group does have a relatively high prospective multiple of 29.

The negative impact of oil & gas

Eight out of the top 10 AIM performers are resources businesses and unsurprisingly seven are oil and gas companies, particularly ones involved in UK production and exploration. Coal miner MC Mining Ltd (LSE:MCM) and fertiliser producer Harvest Minerals Ltd (LSE:HMI) are the other resources companies with fintech company Tintra (LSE:TNT) the exception that proves the rule.

Even these strong performances from oil and gas companies are not enough to have as significant effect on AIM as BP and Shell have on the FTSE 100 – Shell is larger than the entire AIM market.

The current outlook for oil and gas producers remains good, but it would be wrong to assume it will be sustained over the longer-term. There has already been a sharp jump in some UK oil companies just on the news of easing exploration restrictions. Therefore, it would be wrong to anticipate significant gains from here, even though the cash generation of some oil and gas producers is highly impressive.

Can these hard-hit AIM shares recover?

Many of the worst AIM performers are running low on cash and /or have recently had to raise cash at a huge discount to the then market price. Retail brand Joules (JOUL) is an example of the former and its talks about a cash injection from retailer Next (LSE:NXT) have terminated, leaving it with the need to find another source of funding.

Selling larger stakes in AIM companies can be difficult. Octopus has sold its entire 9.93% stake and Canaccord Genuity reduced its shareholding from 9.54% to 4.63%. These sales will knock most share prices, but they will have a bigger effect on a small company such as Joules.

Professional services provider Ince Group (LSE:INCE) is an example of the latter having raised additional funds to reduce debt after the merger with AIM broker Arden Partners. The cash was raised at 5p a share, which was a 58% discount to the previous market price of 12p. Many AIM companies seeking funds are having to put up with these large discounts to market prices.

Trackwise Designs Ordinary Shares (LSE:TWD) has already raised cash at a large discount to the then market price, which was much higher than it is now, but it will need to find more cash funding due to delays in its contract with an electric vehicle manufacturer to supply Improved Harness Technology, a lighter alternative to copper wire.

Some companies that experienced enhanced demand during Covid lockdowns have retained some of those extra revenues, but much of that increase may have been lost. The cost bases have not adapted to this change.

Online wine retailer Naked Wines (LSE:WINE) is one of the worst performers in 2022. Having significantly outperformed during Covid lockdowns as consumers in the US and Europe increased their online wine buying the company has significantly underperformed in the past year. The share price is at its lowest level for two decades – when it was Majestic Wine.

Naked Wines has fallen back into loss, and it is having to be careful in conserving its cash. A representative of a major shareholder joined the board and resigned within one month.

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Other online retailers Gear4music (Holdings) (LSE:G4M) and CMO Group (LSE:CMO) have also been hit by disappointing revenues. Building materials and plumbing retailer CMO benefited from higher DIY spending during lockdowns and spending has subsequently fallen back.

As long as companies like these have strong balance sheets, they can ride out the tougher trading conditions. Share prices in companies with good businesses will recover, although there is a danger some will be snapped up by bidders before shareholders benefit from the full recovery.

AIM will rebound, although it may not happen until there is an underlying improvement in larger companies outside of areas such as oil and gas.

Andrew Hore is a freelance contributor and not a direct employee of interactive investor.