Lookers

A penny stock that did particularly well in 2021 was car dealership Lookers (LSE: LOOK). Its shares climbed 66% as demand for new and used vehicles from cashed-up drivers outstripped supply. Back in September, the small-cap revealed record first-half numbers. Underlying pre-tax profit rocketing to £50.3m over the six months to 30 June, compared to a loss of £36.5m in 2020. 

So what’s the outlook for Lookers? Well, there doesn’t look to be any sign of vehicle demand falling just yet. Used-car prices in December were up 28% on the previous year. A P/E of six also seems very cheap, considering the company’s potential to benefit from the growing popularity of electric vehicles.

Then again, there’s also an argument for saying there will come a point when people simply won’t pay inflated prices and demand will moderate. Margins in this line of work are normally very slim too. 

On balance, I think Lookers could still do well next year and I’d still consider taking a small position today. But will it rise another 66%? I doubt it. 

e-Therapeutics

e-Therapeutics (LSE: ETX) is another penny stock that’s been in scintillating form this year, rising 157%. Contrast this with the FTSE 100‘s 12% gain and it’s not hard to see why small companies appeal to retail investors. 

As impressive as this performance is however, there are a few things that make me cautious. While its technology is clearly useful — allowing scientists to computationally test potential therapeutic interventions and drugs — e-Therapeutics remains unprofitable. That could prove problematic in the event of a major market sell-off. Investors tend to dump ‘jam tomorrow’ businesses first.

Regardless of whether or not a crash happens in 2022, a second thing worth noting is that less than half the company’s shares are actively traded. This illiquidity means it won’t take many transactions to cause violent shifts down as well as up. The former could happen even if e-Therapeutics is in something of a sweet spot, thanks to the pandemic. 

Considering the above, I think there are potentially better opportunities in the market this year and I wouldn’t be a buyer of the stock now.

88 Energy

Alaska-focused, Australia-based oil and gas company 88 Energy (LSE: 88E) is a final penny stock that did superbly in 2021, rising 167%. There are multiple reasons for this, including the company’s efforts to improve its balance sheet (through the sale of tax credits) and the gradual increase in the price of crude oil.

Unfortunately, a lack of profits once again leaves me cold. Befitting a company in this space, it’s also worth pointing out that 88 Energy shares have been volatile. The very same shares have traded for a little as 0.41p and as much as 4.7p over the last 12 months. They currently change hands for 1.41p a pop. As such, I can’t see this penny stock appealing to anyone other than speculative investors. 

While the shares may continue to rally further in 2022 (most likely to do with drilling activity surrounding its Merlin-2 well), I’m content to watch with interest from the sidelines. As far as my own portfolio is concerned, it’s too hot to handle. 

The company released full-year results Thursday. But before I examine them, what does it do? Well, e-Therapeutics is developing AI-based software aimed at speeding up the drug delivery business. The technology is being used to investigate diabetes, Alzheimer’s, Parkinson’s, and other ailments. But what about Covid-19, which has clearly driven the penny share price gains?

The results speak of e-Therapeutics’ new Covid project. It’s using its technology “to identify approved and known drugs, both alone and as synergistic combinations, that could rapidly be repositioned for the treatment of Covid-19.”

That illustrates a key thing I like about the e-Therapeutics drug discovery platform. It’s based on artificial intelligence, analysing existing data to find novel applications for drugs that have already been through the lengthy approvals process. It appears flexible and can be adapted to new ailments relatively quickly. So that’s a definite positive for me. But is it enough for me to buy a penny share?

Show me the balance sheet

No. Technological promise alone will not get me to invest. I’ll only buy if I think a firm’s financial situation stacks up too. I’m also very wary of going for a penny share because I’m painfully aware that most of them got that way by previously commanding higher prices and then collapsing. And that did, in fact, happen at e-Therapeutics. On flotation day back in 2007, the shares were placed at 67p apiece.

The company reported an operating loss of £4.5m for the year to 31 January, after a R&D spend of £2.7m. That’s on rather modest revenue of £0.3m. So, still very much in the cash-burn phase. The year, in financial terms, was very much a fundraising one, in which “the company strengthened its financial position raising total gross funds of £13.2m.”

The biggest equity issue, of £11.6m, happened in July 2020. With the pandemic in full swing, it was clearly a good time to tap the markets for cash. It’s led to a healthy balance sheet, with cash of £13m on the books at 31 January. The huge share price rise, however, has pushed its market capitalisation to £117m. With no profits yet, that implies investors see the future value of that £13m cash rising ninefold.

Will I buy a penny share?

So, will I put my penny share aversion to one side and buy e-Therapeutics shares? In short, no. Not now. I do think I’m seeing some exciting potential in the company’s technology. And the urgency that the current pandemic has forced on the drug discovery and development process can only highlight the value of this technological approach.

I just think the current share price puts too high a value on that potential and leaves little or no safety room to allow for the risks. The main risk I see is that it will take longer then expected to reach sustainable profits, which could result in a share price reversal. If that happens though, I’ll be rethinking it.

A tech solution to drug development

E-Therapeutics is involved in the drug discovery sector of the pharmaceutical industry. Discovering and creating new medicines is a long and expensive process that carries a lot of risks. However, this software company is trying to help change that.

It has developed a proprietary platform that incorporates big data and a suite of powerful tools driven by artificial intelligence to accelerate the drug discovery process. And while the technology only recently launched, it is already being used to investigate type-2 diabetes as well as neurodegeneration diseases such as Alzheimer’s and Parkinson’s.

Why is the penny stock on the rise?

The E-Therapeutics share price started to climb in early 2020, following the release of its results for 2019. It had been a pre-revenue business for many years, and so finally, seeing some form of revenue was exciting. What’s more, overall losses for the year were cut in half, from £5.1m in 2018 to £2.9m in 2019. Combined, this appears to be the primary catalyst for the rising share price. However, I’m far more interested in another announcement made later in the year.

In May, E-Therapeutics announced it had expanded its platform’s capabilities to support RNA interference (RNAi). Without going too deeply into gene science, RNAi enables the manipulation of protein behaviour within the body. RNAi-based therapies can treat a wide range of diseases such as cancer and antibiotic-resistant bacterial infections.

Today the RNAi drug market is worth approximately $39bn. But current forecasts indicate it will grow by an average of 27.2% annually, reaching a market size of $131bn by 2025. Needless to say, that represents an enormous growth opportunity for this penny stock.

Risks to consider

As promising as the technology may be, there are some significant risks to consider. The first being the lack of substantial revenue. In 2020, the firm only generated £0.5m, which doesn’t come close to covering the cost of operations. As such, the business is still dependent on outside funding to keep the lights on.

What’s more, the company is exposed to some significant cyber-security threats. If a breach were to occur that exposed sensitive client data, E-Therapeutics’ reputation could be severely damaged, leading to a potentially significant reduction in future revenue.

The bottom line: a penny stock to buy?

The company’s technology is rather impressive in my eyes, especially given the growth opportunities that lie before it. However, even with its recent progress, I believe it’s too soon to invest, especially at its current share price. The market capitalisation of the stock is almost £100m, despite it only generating a tiny amount of revenue. Therefore I’m not adding E-Therapeutics to my portfolio today.

Shares in Gulf Marine Services (LSE: GMS) dropped 6.6% today despite strong full-year results. With revenue up 12%, the supplier of self-propelled self-elevating support vessels to the offshore oil and gas business reported a 4% rise in adjusted net profit, with adjusted earnings per share (EPS) pretty much flat. The full year dividend was lifted 9% to 1.6p per share, ahead of forecasts.

In a year in which big oil companies have been tightening their belts on support spending, this looks like a pretty decent set of figures to me, and the firm seems to have no financing problems, with a new $620m debt facility in place in the final quarter and improved borrowing margins reported.

Chief executive Duncan Anderson called this a “solid set of results“, but he did say that last year’s turbulence in the markets is expected to “continue throughout 2016” — and that’s probably partly behind the price fall. Forecasts put Gulf Marine shares on a forward P/E for 2016 of only 3.8, dropping as low as 3.2 on 2017 predictions. With EPS growth expected to resume this year, I see that as far too cheap — even if the apparent oil price recovery takes a little longer to become established.

Wafers with that?

It was full-year results time for maker of semiconductor wafer IQE (LSE: IQE) too, although the share price has remained unchanged at 18.75p at the time of writing. After a slump towards the end of 2015, the shares are now down 19% in 12 months, and again we’re looking at a company on a very low P/E valuation — just 6.6 based on forecasts.

Chief executive Drew Nelson described 2015  as bringing in “another strong financial performance“, after adjusted EPS rose 7%. The firm managed to get its net debt down by 26% to £23.2m, and saw operational cash generation rise by 41%. IQE’s intellectual property portfolio is growing, with over 100 patents now in the field of advanced semiconductor design and manufacture.

Mr Nelson also says IQE is “on track to achieve our expectations for the full year“, and as far as I can see his optimism looks to be well placed.  I think we could be looking at another small cap bargain here.

Pills and potions

Finally, biotechnology specialist e-Therapeutics (LSE: ETX), whose shares gained 9% to 13.5p on the release of full-year results. CEO Professor Malcolm Young told us it was a “very productive year for our discovery platform which continues to exceed our expectations by generating high quality, potent compounds“, adding that some have “the potential to be game changers in immuno-oncology, cancer drug-resistance and anti-infection“.

That certainly sounds like a promising prospect, but the big risk I see is that e-Therapeutics still appears to be some years away from profit, with forecasts suggesting  losses continuing at around the current rate for at least two more years. For the year just ended, operating losses came to £11.6m, and I’m a little concerned that the company’s net cash of £24.8m might not last too long at that rate. However, the firm says is is “well funded to advance its programmes“, and top fund manager Neil Woodford bought some last year.

The renowned fund manager told us during the morning:

“I can’t pre-announce my exact investment intentions but I do have a clear idea of what the starting portfolio … will look like. … I can start to build the portfolio this afternoon. I intend to proceed in a careful and considered manner, with a strong, disciplined focus on valuation — I won’t buy any share for the portfolio unless I view its valuation as attractive”.

Mitchell Fraser-Jones, Woodford’s Head of Investment Communications, sounded excited a few hours later, saying of his boss: “He’s rather busy this afternoon!”

RM2 International

One of Woodford’s Thursday afternoon buys was revealed on Friday when AIM-listed pallets company RM2 International (LSE: RM2) disclosed that Woodford Investment Management had acquired 24,000,000 shares (7.5% of the company).

RM2’s non-executive directors are far more glamorous than its business, because they include ex-Diageo chief executive Paul Walsh and former Marks & Spencer boss Sir Stuart Rose. Not bad for a company whose current share price of 52p gives a market capitalisation of a mere £167m.

ReNeuron Group and e-Therapeutics

Drug-discovery firm e-Therapeutics (LSE: ETX) and stem-cell business ReNeuron (LSE: RENE), both AIM companies, also disclosed that Woodford had bought shares on Thursday afternoon.

Woodford Investment Management now owns 17.7% of e-Therapeutics, which has a market capitalisation of £73m at a current share price of 27.5p, and 14.9% of ReNeuron, which has a market capitalisation of £54m at a current share price of 3p.

The number of shares Woodford bought in each company was matched by an identical sale on the same day by his former employer Invesco Perpetual.

AstraZeneca and BAE Systems

Invesco Perpetual also made hefty sales of shares in AstraZeneca (LSE: AZN) and BAE Systems (LSE: BA) last week. Now, because these are companies with much bigger market capitalisations, Woodford — if he is currently buying stakes in them — may not reach a level that is disclosable to the market. It would depend on what weighting he gave them in his fund and how big the fund is. Woodford tells us: “We don’t believe it would be sensible to announce the total amount raised for the fund immediately for reasons of market sensitivity …”

However, Woodford is on record as saying that last month’s £50 a share offer by Pfizer for AstraZeneca was “very distant” from being a full valuation; Astra’s shares now trade at under £44. So, I reckon the master investor would be happy to buy.

BAE Systems is another long-time Woodford favourite, and the shares are currently trading at an undemanding 11 times forecast earnings with a well-above-market-average dividend yield of 4.8%. Again, this looks to me like a company Woodford will be interested in.