Midatech’s first-half performance was upbeat. It was able to successfully integrate and deliver impressive sales performance from its recently acquired US commercial business. This helped it to grow sales by over 1,000% from £0.32m in the first half of 2015 to £3.8m in the first half of 2016. Furthermore, the launch of its anti-nausea product Zuplenz in the US in April has provided a boost to Midatech’s sales and this bodes well for its future performance.

In fact, Midatech is confident on its second-half outlook and in its longer-term prospects. It’s investing heavily in a number of R&D programmes as well as in platform technologies and candidate pipelines. They have the potential to turn Midatech from a lossmaking business to a profitable one over the long run. And with the company’s pre-tax losses set to narrow from £12m to £9m between 2016 and 2017, Midatech is moving in the right direction.

Lower risk?

However,Midatech remains a small and relatively high-risk buy. Therefore, other healthcare companies offer lower risk as well as high potential rewards. Among them is Smith & Nephew. It has a very stable business model owing to its dominant position within wound care and orthopaedics, both of which are more consistent arenas than pharmaceuticals. As such, Smith & Nephew has a low risk profile and with it due to increase earnings by 13% next year, it offers sound growth prospects too.

Hikma is also expected to record upbeat financial performance over the medium term. Its earnings are due to rise by 41% in the next financial year. This puts it on a lower price-to-earnings growth (PEG) ratio than Smith & Nephew, with its PEG being 0.5 versus 1.4 for Smith & Nephew. This indicates that Hikma offers significantly greater upward rerating potential, although with Hikma forecast to record a fall in its earnings of 23% this year, its financial performance is much more volatile than its sector peer.

Think long term

One healthcare stock that offers stunning long-term growth potential is AstraZeneca. Its bottom line has come under pressure due to patent losses, but it’s expected to return to positive growth over the medium term through its acquisition programme. Despite investing billions in its pipeline, AstraZeneca’s balance sheet and cash flow are strong and lower its risk profile significantly.

Alongside this is the potential to make further acquisitions to boost future growth. Due to this, AstraZeneca’s growth potential is hugely appealing even when compared to the likes of Hikma, Smith & Nephew and Midatech.

Furthermore, AstraZeneca yields 4.3% versus 1.9% for Smith & Nephew and 0.8% for Hikma, with Midatech paying no dividend. This means that as well as a low risk profile and strong growth potential, AstraZeneca has the most income appeal of the four stocks. So, despite being attractive, AstraZeneca is the most enticing of this healthcare quartet right now.

During the period, Midatech has also enjoyed multiple positive advances including the launch of Zuplenz in the US to provide relief from the side effects of common cancer treatment, while its outlook for the second half of the year remains as per previous guidance.

Midatech also stated in today’s update that it’s too early to assess the long-term impact of Brexit. However, it hasn’t experienced an immediate impact following the EU referendum.

Stability and resilience

Of course, the weakening in sterling since the vote has been good news for a number of Midatech’s healthcare peers, including GlaxoSmithKline (LSE: GSK). It reports in sterling but derives a major part of its sales from abroad. As a result of this, GlaxoSmithKline’s outlook is positive, since sterling is forecast to weaken yet further against the US dollar and other major currencies.   

Clearly, GlaxoSmithKline has more appeal than just currency exchange effects. Its business model is exceptionally stable and well-diversified, with it essentially being three world-class businesses in one. Its pipeline of around 40 potential treatments is robust and should provide multiple blockbuster drugs over the medium term, while its consumer goods and vaccines businesses also have bright long term growth potential.

As such, GlaxoSmithKline has significantly greater stability and resilience than Midatech and while the smaller firm has a bright long-term growth outlook, it remains high risk. It also lacks income prospects due to it being lossmaking, while GlaxoSmithKline has a yield of 4.7% and the potential to raise dividends over the long run as its pipeline begins to deliver on its potential.

GlaxoSmithKline is also a superior income stock compared to FTSE 100 peer Hikma (LSE: HIK). The latter yields just 0.8% at the present time, but with its bottom line forecast to rise by 53% next year, dividends are expected to grow by 36% in 2017. Hikma’s growth rate puts it on a forward price-to-earnings (P/E) ratio of 18.5 and while this represents fair value for money given its strong balance sheet, long-term growth prospects and sound strategy, GlaxoSmithKline is cheaper.

It trades on a forward P/E ratio of 16.5 and when its treatment pipeline is factored-in, as well as its diverse business model, GlaxoSmithKline seems to offer the perfect mix of defensive characteristics, upward rerating potential and growth prospects. Therefore, while Hikma is a sound buy and Midatech has long-term potential, GlaxoSmithKline is the best buy of the three at the present time.

That’s quite a target because Shire is now a FTSE 100 constituent with a market capitalisation of around £24.64bn, which dwarfs Midatech’s market capitalisation of just £55m. Midatech has a long way to travel but looks as if it’s up to the challenge.

Great expectations

The firm focuses on the development of multiple targeted therapies for major diseases in the areas of oncology, endocrinology and neuroscience, which have unmet medical needs. A three-pronged approach means the company will develop its own products in-house, acquire them, or partner with other organisations.  

Last year’s acquisition of DARA BioSciences Inc gave the firm a commercialisation arm, now called Midatech Pharma US, through which it plans to roll out its commercialisation strategy. Right now, the company has four products in fast growth and two mature products in the US that are driving revenue growth.

In 2015, the company generated around £1.4m in revenues and the chief executive reckons he’s comfortable with the top end of City analysts’ expectations of around £9m in revenue for 2016. Beyond that, Midatech targets £15m during 2017 and at that point expects to break even. However, the top man puts his neck on the block to predict that Midatech’s strategy will lead to revenues counted in the hundreds of millions within five to seven years.

Shire shows the way

Midatech’s business model seems very similar to Shire’s, so I can see why Midatech compares itself with the FTSE 100 giant. In 2015, Shire’s revenue was around £4.35bn, more or less doubling over five years. However, in the earlier stages of Shire’s development revenue growth was more rapid. Shire’s profitable growth certainly shows what might be possible for its smaller peer and if things work out as hoped Midatech’s shareholders could see considerable capital appreciation as the firm’s shares shoot up.

Key to Midatech’s success as an investment from here is whether the firm manages to break even and get into profit without raising funds that could dilute existing investors’ interests. At the moment, Midatech has around £2m in debt, which is low, and £16m or so in cash, which gives the firm a bit of room to wiggle as it moves towards generating profits. I’ll be keeping a close eye on the firm’s losses and looking for a trend that shows they’re reducing.

Higher risk, higher potential reward

Getting into a growth story early before the firm even makes a profit can be lucrative if things go well, but if costs rise as fast as revenues and profits remain elusive, results can be disappointing for investors. That’s why I would classify Midatech as a higher risk investment with potentially higher rewards.

Today’s share price of 165p is more attractive than the 320p or so Midatech reached a year ago and during that time, operational progress has added more value to the investment proposition. There’s a good chance that Midatech could delight its investors in the years to come as Shire did previously.

Allied Minds

Index: FTSE 250 — Share price: 399p — Market cap: £860.4m — Proportion of company owned by Woodford Asset Management: 29.1%

Allied Minds is a science and technology development and commercialisation company. The company forms, funds, manages and builds businesses, based on innovative technologies developed at leading US universities and research institutions.

According to its latest trading update, Allied Minds has a portfolio of 23 subsidiary businesses and “exciting collaborations with industry leaders such as Bristol-Myers Squibb, Intel, AMD and Google”.

At the same time as Woodford was upping his stake, his team noted that “the market appears to be struggling to place an appropriate value on this young technology business”.

I can see why. Companies with no earnings are often valued on the their price-to-sales (P/S) ratio, but on this measure Allied Minds is profoundly overvalued. Revenue for the last calendar year was $4.7m (£3.2m), so with a current market cap of £860.4m, we’re looking at a ridiculously high P/S of 269.

Turning to assets, Allied Minds still appears to be on a very rich rating: five times book value, based on the last published balance sheet (30 June 2015) showing net assets of $270.4m (£172m). A US short-selling hedge fund, in a research report that was of course slanted to its own agenda, did, however, calculate net asset value (NAV) based on Allied Minds’ own higher valuation of its assets. This worked out at $631m (£401m) — so, the company is currently valued in the market at more than twice that implied by the management’s own valuation.

Allied Minds said in its trading update last month that management’s valuation for 31 December 2015, “while still being finalised, is expected to be comfortably ahead of the prior year”. Even so, that sounds like the current share price still represents a hefty premium — which, on the face of it, doesn’t seem a profound undervaluation of what is a portfolio of largely early-stage, illiquid and opaque assets.

4d Pharma

Index: FTSE AIM 100 —  Share price: 850p — Market cap: £550.6m —  Proportion of company owned by Woodford Asset Management: 24.1%

4d Pharma is developing therapeutics based on live bacteria. The company has earned no revenue to date, recently acquired another interesting (but also early-stage) business, and had net assets of £66.6m (£61.5m of which was cash) at 30 June 2015.

If you purchased the whole company today at the current share price, your cash of £550.6m would essentially buy you cash of £61.5m, a few million intangible assets and a lot of hope that Woodford is correct in believing this represents a profound undervaluation of 4d Pharma’s commercial potential.

Midatech Pharma

Index: FTSE AIM All-Share — Share price: 156.5p — Market cap: £52.4m —  Proportion of company owned by Woodford Asset Management: 20.0%

Nanomedicine company Midatech Pharma had net assets of £37.1m at 30 June 2015, so the shares are trading at 1.4 times NAV, which compares favourably with 4d Pharma’s 8.3 times NAV.

Midatech also boasts some revenues, having brought in £0.4m over the 12 months to 30 June. A leap to over £8m is forecast for calendar 2016, with around £14m currently pencilled in for 2017 — which would give a not-outrageous P/S ratio of 3.7 at the current share price.

At the end of the day, though, I have to say that these kind of ‘high hopes’ businesses don’t really appeal to me — even if the redoubtable Mr Woodford reckons their commercial potential is profoundly undervalued.