AIM tips 2018: A game of two halves

He picked a star stock in 2018 and this year's AIM picks have performed roughly in line with the market. Former AIM writer of the year Andrew Hore thinks four of them are still a buy.

The 2018 AIM share recommendations were companies that appeared to have good long-term prospects, although one of them was riskier than the others.  It was that risky company that was doing well half way through the year but ended up dragging the performance down. Only one of the share prices has risen, but the other three have done reasonably well compared with AIM as a whole.

The overall decline of the five stocks for the year was 20.2%, which is worse than the fall in the FTSE AIM All-Share index of 18.8%, but better than the AIM 50 which is 22.7% lower – probably influenced by the slump in the share price of struggling online retail giant ASOS. 

Four out of the five companies are still good long-term investments, however, while the other remains risky although there is some hope, but not in the short-term.

Diurnal Group (DNL)

Original recommendation: 146.5p

Highest post-tip share price: 215.8p (March)

Current price: 22.5p

It is best to start off with the bad performer. The year had started so well. At the beginning of 2018, Diurnal gained European paediatric use marketing authorisation for its Alkindi adrenal insufficiency treatment for children up to 18 years. Alkindi was launched in Germany during May with other European countries to follow.

This is a limited market, but it is potentially lucrative. During March, Diurnal raised £10.5 million at 190p a share to finance the setting up of distribution channels for Alkindi. Initial revenues have been generated. 

The European phase III trial for Chronocort, a treatment for congenital adrenal hyperplasia and adrenal insufficiency in adults, was the major disappointment. The trial unexpectedly found that there was no additional benefit from the drug compared with the standard of care. That contrasted with the phase II results, which were successful. The US phase III trial has been put on hold. 

The problem is that the distribution activities have been set up so that they can handle more than one treatment. The strategy does not make sense for one treatment. Further analysis of the Chronocourt data indicates benefits over a 12-month period. A new regulatory package will be submitted to the European Medicines Agency. That could lead to a submission for marketing authorisation approval and possible orphan drug designation. That will not be until the end of 2019, though. 

More cash will be required before then and, at the current share price, that will be highly dilutive. There should be a floor to the share price because Diurnal has Alkindi and it is building up its revenues. That should attract a buyer if it appears that Chronocourt is either not going to be a commercial product or if it will not be on the market for a long time, which would require even more working capital.

Parity (PTY)

Original recommendation: 9p

Highest post-tip share price: 16p (June)

Current price: 8p

IT services and recruitment company Parity is probably the biggest disappointment of the five recommendations. Diurnal always had a high level of risk, so a volatile share price had to be expected. Parity, though, appeared to have good recovery/growth potential and an impressive ability to generate cash. 

Parity even won a large contract earlier this year, but contract delays have hampered the progress of the consultancy business. This led to the 2018 pre-tax profit forecast being more than halved to £850,000. That represents breakeven in the second half. Net debt is expected to fall from £1.6 million to £1.2 million.

On the bright side, the non-core activities have finally been sold, albeit for below their net asset value.

The 2019 profit forecast was also cut by around one-quarter to £1.65 million. That would mean that the shares are trading on less than six times prospective 2019 earnings. It appears that a dividend is still some way off. 

The strategy remains the same with higher margin consultancy business becoming increasingly important over the medium-term. Non-executive director David Firth has doubled his stake since the profit warning to 200,000 shares. Investor confidence will need to be rebuilt, but the shares appear cheap.

SigmaRoc (SRC)

Original price: 41.75p

Highest post-tip share price: 43.4p (January)

Current price: 39.5p

Building materials sector consolidator SigmaRoc has not done anything wrong this year. Trading has generally gone to plan and there will be significant growth in earnings thanks to 2017's acquisitions. There has been a lack of acquisition activity this year although a deal was secured at the end of the year. 

SigmaRoc will pay £15.2 million for north west England-based precast concrete products supplier CPP Building Products, but it requires shareholder approval to issue shares, so it will not be completed until early January.

This will be earnings enhancing, but there will not be an analyst upgrade until next year after the deal is finalised.

CPP fits well with the existing precast operations in southern and eastern England, where there has already been investment in increasing capacity. In the year to August 2018, revenues were £20.9 million and EBITDA was £2.6 million.

There are also plans to refinance the convertible loan notes. This should reduce financing costs. The Santander loan facility is being increased from £20 million to £34 million to fund the acquisition and the redeeming of the convertible.

Nigel Wray has increased his stake in SigmaRoc from 3.91% to 4.24%, following the acquisition announcement. This is an endorsement of the prospects for the business, which is trading on just under ten times prospective 2019 earnings even before any upgrade.

The strong businesses and management ability to make good acquisitions means that the shares are still a buy. 

Share prices and index levels for full-year performance as at 18 December 2018.

Source: interactive investor. Past performance is not a guide to future performance.

Mercia Technologies (MERC)

Original recommendation: 36.25p

Highest post-tip share price: 44.86p (January)

Current price: 29.5p

Technology businesses developer and fund manager Mercia Technologies was always likely to be more suited to a longer time frame, but I thought the share price could still rise over the year. That has not happened, and it has gone the other way. There are no problems with the company it will just take longer for valuation uplifts to come through as the investments mature.

Mercia's investment focus is on software, digital, electronics/engineering and life sciences. The fund management business enables Mercia to observe early stage businesses and choose ones to directly invest in later in their development. It also generates fees to cover most of the costs of the group and limit the trading loss.

The net asset value (NAV) edged up to 41.3p a share at the end of September 2018. The shares are trading at a 25% discount. Edison reckons that profit generated from the Mercia Fund Managers business could be worth a further 9p a share.

There is still £38.2 million of cash on the balance sheet, more than one-third of net assets, and this can be invested in new and follow-on investments to provide further long-term growth.

What Mercia needs is some more exits or further successful commercialisation by some of its investments that would lead to an uplift in valuations. Long-term buy. 

Next Fifteen Communications (NFC)

Original recommendation: 423p

Highest post-tip share price: 613.5p (September)

Current price: 502.5p

The star of the 2018 recommendations is Next Fifteen Communications. The PR and social marketing company has continued to meet expectations and grow steadily, as well as making acquisitions. The international nature of the business has helped with a dip in the US profit contribution more than made up for by a jump in UK operating profit at the interim stage. 

A major focus of expansion is digital marketing. In November, Next Fifteen raised £20 million at 475p a share and some of this was used to finance the acquisition of Activate Marketing Services for an initial $9 million in cash. This technology-focused business is data-led and will continue to be operated separately.

The group has a strong market position in the technology sector, but it is also growing elsewhere. It paid an initial £2.2 million for Technical Associates Group, which is a technical content and digital marketing business. This deal increases the group’s exposure to the industrial engineering sector. 

In the six months to July 2018, revenues were 14% ahead at £106.8 million and underlying pre-tax profit was 26% higher at 14.2p a share. There was organic revenue growth in each of the company’s regions, with the strongest growth, of 14.9%, in the UK. 

Next Fifteen can afford to pay a growing dividend and reduce its debt. A 2018-19 pre-tax profit of £35.8 million is forecast, with £42.6 million expected for next year. Despite the latest share issue earnings per share are growing in the high teens in percentage terms. The shares are trading on 15 times this year's prospective earnings and the forecast yield is 1.5%, with the dividend also growing at a percentage rate in the high teens. Still good value. 

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