Looking ahead, further challenges could be ahead for the UK retail sector. But with the stock having what appears to be a sound growth outlook, it could be worth a closer look alongside a smaller stock that reported positive news on Monday.

Growth potential

The company in question is radiation detection technology firm Kromek (LSE: KMK). It announced news of a new long-term supply contract worth a minimum of $7.8m for an existing customer within the baggage security screening market. The contract covers a five-year period and starts immediately.

Today’s news follows other multi-year contracts as customers continue to embrace new technology, with the company appearing to be well-placed to capitalise on growing demand at a time when security is becoming an increasingly important factor for a range of organisations. The company’s ability to deliver customer-specific detector modules and deploy them in advanced screening systems for real-world use could mean that demand for its products remains high.

Although Kromek is expected to remain loss-making in the next two financial years, the long-term prospects for the business could be relatively bright. While potentially risky, it could deliver high rewards over the long run. As such, it may be worthy of consideration for less risk-averse investors.

Improving prospects

As mentioned, Morrisons has undergone a transformation in recent years. The company has been able to increase its exposure to the wholesale industry, with it seeking to build on its status as a major food producer and distributor. This has helped the business to gain additional exposure to faster-growing areas such as convenience and online opportunities, where previously it had arguably been behind some of its industry peers.

As well as this, the company has expanded areas such as its loyalty programme, while also increasing staff pay as it seeks to deliver an improved customer experience. With a special dividend having been paid in the last two financial years, the company’s management appears to have confidence in its future growth outlook.

Although the prospects for the UK food retail industry remain somewhat challenging, the outlook for Morrisons could be relatively positive. The company is forecast to post a rise in earnings of 8% in the current year, followed by further growth of 10% next year. As such, it seems to have a bright future ahead of it, with its revised strategy appearing to offer a strong catalyst for its financial performance.

While there could be further uncertainty ahead for a variety of retail shares in the UK, the company appears to have found the right plan through which to outperform the FTSE 100 in the long run, in my opinion.

I last wrote about the company in December when it reported 27% revenue growth in the first half of its financial year. It said it was well positioned to achieve EBITDA break-even for the full year. The shares were trading at 25p at the time and I rated the stock a ‘buy’ on its valuation of 5.2 times forecast full-year revenue. How has the company performed since, and is the valuation still attractive today?

Highly lucrative prospects

The full-year results saw Kromek’s revenue growth accelerate to 32%, with £11.85m booked on the top line, and a £0.5m maiden EBITDA profit. Net cash at the year end (30 April) was £6.5m. The revenue growth was driven by continued delivery on previously-signed agreements, as well as commencing delivery on new high-value contracts won during the year. The company also continued to protect its technology, filing seven new patents and having 29 granted during the period.

Contract news since the year end has been strong. The latest announcement (today), is that the US Defense Threat Reduction Agency is funding Kromek to the tune of $1.8m to develop a next-generation military-grade version of its civilian D3S handheld radiation detection device. If successful, I believe commercial follow-on orders, not only from the US, but also potentially NATO, could be highly lucrative.

Kromek’s shares are up 7.5% to 28.5p today, giving the company a market capitalisation of £74.2m. This is 4.9 times current-year forecast revenue of £15.05m — a cheaper rating than when I wrote about the stock last year. As such, I continue to rate it a ‘buy’.

Good buying opportunity

Fellow AIM-listed small-cap Gear4music (LSE: G4M) is ahead of Kromek in its development. Revenue is expected to burst through the £100m level this year and at a current share price of 517p, the company’s market capitalisation is £108m. However, it’s still at a relatively early stage of growth and is another business I’d happily buy a slice of for its terrific potential.

Gear4music is already the largest UK-based online retailer of musical instruments and music equipment but it’s also rapidly increasing its international reach. In its last financial year (to 28 February), the UK contributed £44.3m to group revenue (up 27% on the previous year) and International contributed £35.8m (up 69%).

It was a year of heavy investment for the company but net debt at the year end was a modest £5m and the investment in the business gives it a platform for further strong growth. City analysts are forecasting annual earnings increases of over 50% this year and next. The share price got as high as 865p last October and I believe the decline to the current 517p represents a good opportunity to buy in. The valuation is still a premium one — 50 times this year’s earnings, falling to 32 times next year’s — but I reckon the growth potential is such that the rating is more than merited.

Growing reputation

The company designs, develops and produces x-ray and gamma ray imaging and radiation detection products for the medical, security screening and nuclear markets. The period under review saw higher product sales across these key markets, as well as the continued winning of new high-value contracts.

Its D3S product, which it describes as “the world’s most advanced, portable, nuclear radiation detection device,” was successfully deployed in high-profile situations for safeguarding against nuclear terrorism, including the NATO Security Summit and Donald Trump’s visit to Brussels in May. And the company also enjoyed reputation-enhancing successes in its other key markets.

Attractive valuation?

Analysts are forecasting revenue of £12.5m for the full year (almost 40% ahead of last year) and Kromek appears to have substantial commercial opportunities in the medium and long term, including from an $8.2bn US Department of Defence security programme.

The shares have fallen quite heavily on today’s results — down 8% at 25p, as I’m writing. This values the AIM-listed firm at £65m, which is 5.2 times forecast revenue. Personally, I view this as an attractive multiple and rate the stock a ‘buy’, albeit a risky one, due to it being an early-growth and currently lossmaking business. Risk-averse investors may want to monitor progress from the sidelines for the time being.

I put today’s share price fall partly down to the inherent volatility of small-caps and partly down to the fact that, while Kromek is moving rapidly towards EBITDA breakeven, cash burn in the first half was £5.3m. However, I note that £3.7m of this was investment in development and working capital and that the company is well funded for the year ahead with net cash on the balance sheet of £12m.

Terrific buy?

Fellow AIM-listed firm Idox (LSE: IDOX) is already profitable, and has been for a good number of years. However, recent problems have seen its shares collapse 58% from 65p to 27p in the space of just over five weeks.

On 14 November, in a trading update for its financial year ended 31 October, the software provider, which counts over 90% of UK local authorities among its customers, said sign-off on some contract wins had been delayed beyond the end of the financial year due to customer disruption in the wake of June’s General Election.

This was hardly the end of the world, as the board’s lowered EBITDA expectation of £23m was still above the prior year’s £21.5m. However, in a further trading update on 13 December, it lowered its expectation to £20m. This was due to an internal review in preparation for the full-year audit identifying “a small number of revenue items that it does not consider should be recognised in the FY2017 results.” It added that “clarification of these issues has been complicated by the sudden absence of Andrew Riley, Idox’s CEO, due to illness.”

The stock could prove a terrific buy at the current level but the nature of the news is disconcerting enough to persuade me to wait for the company’s final results in February.

Ramping up revenues

Kromek is a radiation detection technology company focused on the medical, security screening and nuclear markets. It said 2016/17 was “another year of good progress and ramp-up in commercial activities with revenue growth driven by higher product sales across [its] three key target markets.”

Revenue for the year increased 7.5% to £9m but 2017/18 will see a step change as revenue comes through on large-scale contracts that have been secured over the last 24 months. Management said: “The group expects to report year-on-year revenue growth of approximately 40%, in line with market expectations.” So we’re looking at about £12.6m.

Kromek isn’t currently profitable, reporting a £3.1m bottom-line loss today, having expensed £3.5m of research costs for products and platforms that it said are “linked to existing contract deliverables and significant future revenue opportunities.”

The company had cash of more than £20m on its balance sheet at year-end (thanks to a fundraising in January) and has a good number of institutional investors on its shareholder register. While the cash pile means I’m unconcerned by Kromek’s current lossmaking status, it also means I have to value it on revenue rather than profit at this stage.

Valuation

At the current share price of 33p, the market capitalisation is £85m, so the stock trades at 6.8 times next year’s guided revenue of £12.6m. This looks an enticing multiple to me for an early-growth business, whose advanced patent-protected technologies are gaining increasing traction in the attractive medical, security screening and nuclear markets.

The shares appear very buyable to my eye, although as a higher-risk investment this is a stock I would only take a small stake in at this stage of its development.

Demographics growth driver

ConvaTec (LSE: CTEC) is another stock in the health sector I’ve got my eye on. This FTSE 100 firm is a lower-risk proposition than Kromek but, like the small-cap, its share price has fallen back somewhat after a strong run. ConvaTec’s shares climbed from 234p at the start of the year to a high of 344p but are currently trading at 327p.

In a Q1 trading update released last month, the company reported revenue growth in its Advanced Wound Care and Ostomy Care divisions of 4.2% and 3.3% respectively. It saw flat revenue in Continence & Critical Care (due to margin improvement measures) and a 3.1% decline in Infusion Devices division (due to anticipated customer inventory reductions). But management reaffirmed its previous guidance for 2017 of group organic revenue growth in excess of 4% at constant currency.

On the back of this, the City consensus is for ConvaTec to deliver earnings per share of $0.20 (15.6p), giving a price-to-earnings ratio of 21. This is not a premium rating by the sector standards and with demographics providing a long-term driver for growth, the shares appear to be an attractive buy.

Improving outlook

Reporting on Friday was radiation detection technology company Kromek (LSE: KMK). Its shares increased in price by over 8% following the update, which shows that investor sentiment continues to improve. This takes the company’s gain in 2017 to around 29% versus just 1.5% for the FTSE 100.

Kromek’s update stated that it is making good progress on the delivery of new orders won over the past two years. Due to this, it is continuing to trade in line with expectations. Its products have gained traction in all of its business segments from the increasing adoption of CZT-based technology and other products. More customer wins are expected in future, with Kromek anticipating a step change in revenue in the new financial year.

In fact, the company is expected to report a narrowing of the losses of recent years. Following a pre-tax loss of £4.1m in 2016, it is due to post a pre-tax loss of £3.7m in financial year 2017. This is then expected to narrow to a loss of £2.1m in financial year 2018. Given it has taken part in a successful fundraising and investor sentiment seems to be on the up, now could be the right time to buy a slice of the business.

Recovery potential

Also offering FTSE 100-beating performance is Judges Scientific (LSE: JDG). The scientific instrument business has experienced a difficult period of late, with its bottom line being highly volatile and causing its share price to disappoint somewhat. However, since the start of the year there has been an improvement in investor sentiment, with the company’s shares rising by 20% year-to-date.

Looking ahead, more growth could be on the horizon. Judges Scientific is expected to deliver a rise in its bottom line of 24% in the current year, followed by additional growth of 12% next year. Since investors are understandably somewhat cautious about its prospects owing to its disappointing profit falls in recent years, the company has a relatively wide margin of safety at the present time. It trades on a price-to-earnings growth (PEG) ratio of just 1.1, which indicates that it offers a favourable risk/reward ratio.

Of course, there is no guarantee that Judges Scientific will deliver on its upbeat forecasts. However, the company seems to have turned a corner and now has the right strategy through which to improve on its rising share price.

Indeed, most placings are conducted at a discount to a company’s prevailing share price, as that’s the only way managers can get investors to stump up more cash. It’s rare that a company completes a placing at a premium.

Kromek (LSE: KMK) was able to accomplish this goal a few days ago. The company announced on January 25 that management was looking to raise £21m via way of a placing and open offer. The firm placed 100m ordinary shares at a price of 20 per share, the closing middle market price on 24 January. What’s even more impressive is that, at the time of writing, Kromek’s market value is only £33.2m, so the company was able to get away with tapping shareholders for three-quarters of its market value in cash without offering any substantial discount.

Impressed with the company

The very fact that investors were willing to commit to such a significant capital raise without demanding a discount shows that Kromek’s key institutional investors trust the company and its management, and believe Kromek has a bright future ahead.

Kromek’s three primary markets — medical, security and nuclear detection — are all worth many multiples of the company’s current market capitalisation, presenting a tremendous opportunity for the group. Management is already working hard to capitalise on the opportunities available, but has apparently been stonewalled by some customers because of the company’s lack of production capacity. £21m of fresh capital should help prove to customers that the business can be relied upon to make good on customer order commitments.

Customers base growing

One of the firm’s main customers is the US government. The company is working on D3S hand-held radiation detectors with it, and this market alone represents a potential opportunity of $1bn over the next ten years. Kromek has the skills and capabilities to take on these massive markets, but the group is only in its very early stages of growth. 

Still, 2016 promises to be the strongest year on record for the group with over £22m of contracts awarded for the year to November, the largest value of contracts ever won in a year by the company. For the fiscal year ending 30 April 2017 City analysts expect the group to report revenue of £8.9m and a pre-tax loss of £3.7m for the year after, revenue is expected to hit £12.5m and losses should fall to £2.3m.

These forecasts look good, but could be subject to substantial revisions higher if Kromek’s fundraising convinces new customers to use the group’s services. A wave of new contracts could see the group report its maiden profit sooner than expected.

Undervalued 

With the revenue set to grow by 40% next year and a cash rich balance sheet, shares in Kromek deserve a premium valuation. 

Right now the UK technology sector trades at an average price to sales ratio of 11.4. Assuming Kromek deserves a similar valuation the company’s market capitalisation could hit £143m by 2018. Using the same valuation methodology, if the firm hits City revenue targets for this year, the company’s market capitalisation could hit £100m that’s an upside of 220% from current levels.

Overall, it looks as if the future is bright for Kromek.

Although we don’t believe in timing the market or panicking over every stock fluctuation, understanding how a business is performing, competing and changing is vital to sensible investment.

What:  The share price of Kromek Group (LSE: KMK) — an Anglo-American company that supplies radiation detection technologies to the medical imaging, nuclear, and security screening markets — is up over 10% so far today, following the announcement that the company has signed a number of new contracts.

So What: The US Defense Threat Reduction Agency has awarded Kromek a contract worth $1.45m over the next two years, for the design, manufacture and optimisation of high sensitivity solid-state detectors for the homeland security radiation detection market. In addition, contracts worth $950,000 have been signed with a range of clients, both in the US and around the world, for nuclear detection products. The contracts will deliver revenue from now until the end of the 2015 financial year.

And the UK’s Technology Strategy Board (a government agency aimed at fostering innovation) has granted Kromek a contract worth £150,000 over the next year, for the development of conformal detectors that can be wrapped around or positioned inside regions of interest — eg, breasts, limbs, suspicious packages, parts needing inspection.

What Now:  Commenting on the contract wins, CEO Arnab Basu said

“We continue to win new customers in our key markets, highlighting the strength of our technology and the growing adoption of the new capabilities we can offer to partners and customers across the world.  We look forward to updating shareholders as to further progress from our strong pipeline in due course.“

Despite this morning’s rise, at 56.9p, Kromek’s share price is still 24% down so far in 2014, versus an essentially flat FTSE All-Share index. However, it’s only down 2.1% since Kromek listed on AIM back in October 2013, although the FTSE All-Share has gained 3.4% ove the same period.