Zotefoams’ share price rises on record earnings

As a quick reminder, Zotefoams is a cellular materials specialist. The company produces a range of foams used in a vast number of applications, from aeroplanes to footwear.

Despite what the lacklustre performance of Zotefoams’ share price throughout most of 2021 would indicate, revenue has been growing at an impressive rate. And looking at the latest earnings report, this trend has not changed. Sales over the past three months came in 11% higher than last year. And that growth rate increases to 35% when comparing against pre-pandemic levels.

A good chunk of this new-found revenue is driven by the return of demand for its polyolefin foam products. Now that customer production facilities are reopening, sales of this product line are back on the rise and not by a small margin. Compared to 2020, sales grew by 75% over the same period.

Meanwhile, the investments made into its soon-to-be-launched mono-material barrier, ReZorce, seem to be paying off. ReZorce is a potential replacement for existing beverage carton materials, and it’s 100% recyclable. Management hasn’t been too generous with the details. But ReZorce is apparently meeting expectations and could soon be entering the marketplace.

This is all quite positive news, so seeing the Zotefoams share price rise on this report isn’t too surprising. But I do have some reservations.

The risks that lie ahead

As mentioned earlier, revenue growth has been delivered for most of 2021. So why has the Zotefoams share price not reflected this? The issue lies in the profit margins. The pandemic is close to an end and is no longer as disruptive on the demand and manufacturing side of the business. However, it’s still creating problems on the supply side of the equation.

Global supply chain disruptions have triggered a substantial increase in raw material costs, especially for polymers. Combining this with general price inflation has resulted in gross margins falling to around 28.9% from 34.8%. And management doesn’t foresee this problem being resolved any time soon.

The bottom line

Zotefoams as a business seems to be in a much stronger position than a year ago (even if its share price disagrees). However, I’m concerned about the degree of impact supply chain issues are having on margins. It’s unclear for how long these adverse effects will persist. And for the most part, they’re out of management’s control. Therefore, I’ll be keeping this stock on my watchlist for now.

Why did investors run for the exit? First, because it felt like an emergency – the update was delivered a month earlier than usual. Second, the company confirmed earlier warnings by announcing that sales for the second half of 2019 will be around £2m lower than in the first half.

Growth exit

Polyolefin foam sales account for just shy of 70% of the company’s revenues, but are facing continuing headwinds in Europe, particularly in Germany, as well as new ones in the US. Zote’s High-Performance Product (HPP) business unit is doing well, but given its smaller size, that is not enough to prevent expected year-on-year sales growth being essentially flat for the first time in years. Those headwinds gave investors a chill.

Zote’s share price has soared by over 1,000% since 2008, to hit an all-time high of 700p at the end of 2018. Although the dividend has grown by a fairly consistent 3% per year, yields are tiny as they could not keep up with the soaring share price trading at over 30 times earnings per share.

This was a growth story, and the next chapter was going to be about hitting £100m in revenues in 2020. However, that doesn’t look likely to happen now – the growth story looks to have ended, and now the share price is around 20 times per-share earnings.

Investing in extra capacity now looks misguided as operating margins will be squeezed while machines stand idle, and investors may be looking hard at a minor business unit that has been generating increasing losses.

Enter value?

But sifting through the wreckage of the crashed share price, not everything is a write-off. Zote’s polyolefin foams are used in a wide range of applications and markets. Extra foam capacity was added mainly in the US, where demand is not suffering as much as in Europe. A weaker pound has helped Zote’s exporting business. The company’s greater UK capacity will serve the growing HPP business. 

Although new debt has been taken on in the expansion, the company generated enough operating income to cover its interest obligations at least 10 times over in the first half of this year. The loss-making business is expected to have a much stronger second half, and has green credentials as its technology uses up to 20% less material in manufacturing.

I believe Zote will cope with the slowdown. However, if sentiment has shifted, dividends become more important. The total dividend for the year is 6.18p per share, and assuming 3% growth continues (the dividend has not received any warnings) the forward yield is 1.81%.

I would not buy this stock just for its dividends, not would I buy it for its growth prospects because there is too much uncertainty. Although the price has stabilised, I am going to wait until the stock decides if it’s a growth story or a value one.

What’s more, many of the companies in the FTSE 100 today are constricted by their size. It’s easier for a tiny business to double its size — and your money — than for a big one.

With that in mind, here are two small-cap growth stocks that I believe could be much better investments than the FTSE 100 today. 

Earnings double 

With a market cap of £261m, Zotefoams (LSE: ZTF) flies under the radar of most investors. The company, which produces cellular material used in a range of industries including packaging, transport, medical and construction, has seen net profit nearly double over the past three years as sales have jumped 43%. 

Analysts had been expecting the company to report an increase in net profit of 38% for 2018, but it now looks as if the group is set to beat this projection. In a trading update published this morning, management said that “full-year revenues and profit before tax are now expected to be slightly ahead of consensus market expectations.” All of the business divisions reported growth in the first nine months of 2018 and it seems that the firm just can’t keep up with demand.

New production facilities are on track to open in the UK and US next year. In 2020, a new facility in Poland is set to open its doors too. Management’s expansion efforts indicate to me that Zotefoams is planning for a significant increase in demand for its products over the next few years, and now could be the time for investors to get on board

The stock is changing hands today at 30 times forward earnings, which is right at the top end of what I would consider acceptable for a growth stock. However, the recent update is enough to convince me that the shares are worth this high price. If profits go on to double again over the next three years, as they have in the last three, investors could be well rewarded.

Attractive margins 

Another small-cap that’s recently caught my eye is Medica (LSE: MGP). What I like about this health-tech business is its robust profit margins. For the past five years, the operating profit margin has averaged 21%. And profits have exploded since 2015. Earnings per share (EPS) jumped 157% in 2016, 42% in 2017 and are set to grow 37% for 2018. 

However, despite the explosive growth, it seems that the rest of the market has not woken up to the opportunity here. Shares in Medica are currently trading at a forward P/E of just 18.3, falling to 15.9 for 2019, which looks too cheap to me. 

Alongside the company’s unaudited half-year results, management confirmed that Medica is on track to hit City growth forecasts for the year, and strong cash generation will mean that by year-end, net debt will be close to zero from £2.5m at the halfway point. I reckon moving to a net cash position will result in acquisitions that could help accelerate EPS growth in the years ahead. There’s also the possibility of higher cash returns for investors. 

While this increase means that the firm now trades on a rather off-putting valuation of 31 times expected earnings for 2018, I still think the stock warrants attention from growth investors keen on achieving financial independence, especially after today’s positive interim update.

Strong order book

Group revenue climbed 12% to a record £37.9m in the six months to the end of June. At constant currency, this rise equated to a 17% improvement on the same period in 2017.

The above included a 4% increase in revenue from its Polyolefin Foams, thanks in part to the firm’s decision to increase capacity at its base in Kentucky, USA.

Even more impressive were sales figures relating to Zotefoams’s High-Performance Products. These jumped 82% over the period and now contribute 24% of total sales, compared to 15% a year ago. 

Collectively, this trading helped the company register a 64% jump in pre-tax profit to £4.6m.

Continuing the trend of consistent-if-modest dividend hikes, Zotefoams also announced a 3.1% increase to its interim payout this morning (to 1.97p per share). While the forecast 1.1% is hardly tempting, modest dividend increases are more preferable in my book to high yields that can’t be maintained.  

Ultimately, however, Zotefoams remains focused on becoming a far bigger beast. With three projects to expand capacity running to plan, CEO David Stirling stated that the company had commenced H2 with “a strong order book, a differentiated product portfolio and continued growth expectations across all business units“.

Returning to the valuation, it’s true that a lot of growth already appears priced in. Nevertheless, a P/E of 26 in 2019 — assuming expectations are met — looks far more palatable. This being the case, I wouldn’t blame growth hunters from keeping the firm on their watchlists.

Long-term hold? 

Also reporting half-year results this morning was actuator manufacturer and flow control company Rotork (LSE: ROR). Like Zotefoams, the £3bn cap’s shares have been on a roll, rising 52% over the last year and today’s positive numbers were — perhaps inevitably — also greeted with a drop in the stock price.

Revenue rose 14.8% to £331m over the six months to the end of June while pre-tax profit climbed 17.2% to £54.7m. Another reliable dividend-hiker, Rotork declared a 7.3% rise to its interim payout (2.2p per share). 

CEO Kevin Hostetler reflected that the company had witnessed “a continuation of the more favourable market trends” seen in Q4 of the previous financial year and had also received “several large orders” during Q1, contributing to a 13.3% rise in order intake over H1. Rotork expects “high single-digit” growth for the full-year and adjusted operating margins to be “slightly ahead” of those achieved in 2017.

Since the aforementioned orders was already known by the market, today’s fall smacks of profit-taking. That said, the announcement that an investment programme in areas such as service infrastructure and IT has been initiated might have also contributed, particularly as the amount of cash dedicated to this “will continue to increase through the year”.

Based on analyst projections, Rotork’s shares change hands on a punchy 28 times earnings following today’s fall. So long as your time horizon runs to years rather than weeks, I see no reason to jettison the stock as things stand.  

Strong fundamentals

TI Fluid Systems (LSE: TIFS) is one stock which you may have never heard of, but I believe it deserves far more attention from the investment community because of its leading global market positioning.

The company, which designs and manufactures automotive fluid storage, carrying and delivery systems, has a global manufacturing presence and a long-standing technical expertise that earns it strong global market positions in the key markets in which it operates in. Based on production volumes in 2016, the company had an estimated market share of 35% in the brake and fuel line market, in addition to a 15% share in the plastic fuel tank market

Amid favourable tailwinds, most notably rising global light vehicle production, TI Fluid Systems’ revenues and profits have grown robustly. Most recently, in 2017, revenue increased by 4.2% to €3.49bn, while profit for the year climbed to €115.2m, up from €43.9m a year earlier, after it was partially boosted by a lower tax expense.

Undemanding valuations

Going forward, City analysts are highly excited. Adjusted earnings per share are expected to rise by 62% this year to 36.9p, giving it a forward P/E of only 6.8. And out of five analysts covering the stock, three have ‘strong buy’ recommendations, while the other two are ‘holds’.

However, one concern in the longer term is the growing adoption of electric vehicles. While TI Fluid Systems claims it is well placed to capitalise on growing demand for thermal management systems needed in electric car batteries, it remains to be seen whether the company can more than offset the loss from its Fuel Tank and Delivery Systems business. This currently accounts for no less than 40% of its total revenues.

Earnings growth

Looking elsewhere, Croydon-based Zotefoams (LSE: ZTF), a materials technology company which manufactures high-performance polymer foams, also looks poised to deliver impressive earnings growth in the near term.

City analysts expect Zotefoams to deliver an increase in adjusted EPS of 10% this year, with a further increase of 25% pencilled in for 2019. This puts its shares at 34.6 times this year’s expected earnings (or 27.7 times its forecast earnings in 2019) — a substantial premium to the market.

However, quality always comes at a price. On the upside, Zotefoam’s longer-term fundamentals are in really good shape. The company is seeing positive trading momentum, as recent results showed continued organic revenue growth across its key markets. It also recently completed its major US expansion investment, which would boost its production capacity in anticipation of a ramp-up in sales of high performance foams.

Opportunities opening up

News in December that the company secured a partnership with Nike to exclusively develop and manufacture foam innovations for a new generation of high-performance athletic products sent shares in Zotefoams sharply higher. They’re now worth 40% more than before the announcement, reflecting investor belief in the long-term growth prospects of its higher-margin high-performance materials.

Given these opportunities opening up for the business and the company’s unique IP strength, I reckon Zotefoams is on course to deliver robust earnings growth for a number of years to come.

However, the company now seems to offer a wide margin of safety which could lead to a rising stock price in future. But it’s not the only stock which could offer growth at a reasonable price. Reporting on Tuesday was another company that could be worth buying right now.

Improving outlook

The company in question is cellular material technology specialist Zotefoams (LSE: ZTF). It reported a record 2017 financial year for sales and profits. Revenue increased by 22% to £70.15m, experiencing strong growth across its business. This helped to push reported profit, before tax and exceptional items, to an all-time high of £8.81m. This is an increase of 22% and shows that the company’s strategy appears to be sound.

During the period, Zotefoams was able to complete its major US capacity expansion investment that’s now producing high-quality foam. The company is also investing in capacity expansion as it prepares for future growth. And while the macroeconomic environment remains uncertain, near-term growth potential remains high.

Looking ahead to its performance in the current year, the stock is expected to record a rise in earnings of 8%. This is expected to be followed by growth of 24% next year. This puts the company on a price-to-earnings growth (PEG) ratio of just 0.9, which suggests that it offers excellent value at the present time. As such, now could be a good time to buy it for the long term.

Recovery potential

Conviviality could also deliver share price growth in future. Certainly, investor sentiment is likely to remain weak in the near term after forecast news was released. This may have hurt confidence in the company’s future prospects and its ability to generate accurate forecasts. However, if it’s able to deliver on its current guidance, then it would be unsurprising for investor sentiment to gradually improve.

With the stock forecast to post a fall in its bottom line of 17% in the current financial year, its share price may remain subdued in the near term. However, with growth in earnings of 2% forecast for next year, followed by 13% in the year after, a turnaround could be on the cards. And with the company trading on a PEG ratio of 0.3 following its recent share price fall, it appears to offer a wide margin of safety.

Of course, the prospects for UK retailers remain challenging. Consumer confidence is low and this could hurt spending levels. But with such a low share price, Conviviality seems to be a worthwhile turnaround stock for the long term.

Despite this, there are still a number of opportunities to find good value stocks with wide margins of safety. Here are two prime examples which could be worth buying today.

Improving performance

Reporting on Wednesday was cellular materials technology company Zotefoams (LSE: ZTF). The company’s trading update for the 2017 financial year was relatively positive and showed that it was able to continue the strong trend seen in the first three quarters of the year. Full-year revenues are expected to be ahead of current market expectations, while adjusted profit before tax and exceptional items is due to be at the top end of forecasts.

There was strong performance across all of its business units. There has also been further development of the portfolio of future opportunities, with a strong order book allowing the business to enter 2018 with confidence. Encouragingly, the company’s US plant construction has been completed. Commissioning has now begun, with a handover to manufacturing expected to occur in February.

Looking ahead, Zotefoams is expected to report a rise in its bottom line of 16% in the current year. This puts it on a price-to-earnings growth (PEG) ratio of just 1.6, which suggests that it offers excellent value for money at the present time. With a solid track record of earnings growth and a positive outlook, the stock could deliver high levels of share price growth in the long run.

Uncertain outlook

Of course, even though the global economy is performing relatively well, some sectors continue to have uncertain futures. One example is the UK retail sector, where companies such as Next (LSE: NXT) continue to experience difficult trading conditions. This is not particularly surprising, since higher levels of inflation have caused consumers to have less disposable income in real terms. This seems to be changing their shopping habits and may mean reduced sales across the sector.

However, Next seems to be performing well when compared to its sector peers. Its recent update showed that it has been able to grow online sales, while the decline in store sales was lower than expected. As such, the stock could deliver better growth than many investors anticipate.

With a price-to-earnings (P/E) ratio of just 12, Next seems to offer good value for money right now. Certainly, it may lack earnings growth over the next couple of years, and its share price could remain volatile. But for long-term investors, now could prove to be an opportunity to buy it ahead of a period of significant capital growth.

In addition to collaborating on developing footwear technology, the Croydon-based business has agreed to supply the $100bn cap firm with its “high-performance foam materials“. These — the former claims — are not only superior “in performance, consistency, quality and purity” to those produced through alternative methods, but can also be formulated to client specifications. 

Today’s hugely encouraging news builds on the positive trading update released by the company at the start of November.

Back then, it was announced that group revenue had been 22% higher in Q3 than over the same period in 2016 (and 24% ahead over the first nine months of 2017) as a result of “strong organic growth across all business units“. Sales rose 16% over the quarter once currency fluctuations had been taken into account.

Thanks to this excellent performance and a bulging order book, full-year revenues at Zotefoams are now likely to come in ahead of market expectations. Adjusted profit before tax and exceptional items is also forecast to be at “the top end of the range” of analyst predictions.

Taking today’s rise into account, Zotefoams’ share price is 92% up from exactly one year ago. As you might expect, that means the stock isn’t quite the bargain it once was. A forecast price-to-earnings (P/E) ratio of 26 for the full year certainly leaves little room for error.

Nevertheless, this morning’s news — combined with the firm’s strategy of increasing investment in new equipment with the intention of becoming a global leader in what it does — suggests to me that it is still worthy of serious consideration by growth-focused Fools.

Game on

Also announcing news today was £900m cap technical services provider Keywords Studios (LSE: KWS) — one of the standout performers of the junior market in 2017.

Acquisition-friendly Keywords informed investors that it had purchased game development, art creation and software engineering firm Sperasoft for $27m as part of its ongoing strategy to “selectively consolidate the highly fragmented market for video games services.” Funded from a combination of existing resources and equity, this new addition to the Dublin-based firm’s portfolio is expected to be earnings enhancing in the first year. 

A quick scan of Sperasoft’s recent performance goes some way to explaining why Keywords was so keen to take the US-headquartered company under its wing.

Thirteen years after its inception, the company employs 400 members of staff and boasts production studios in Russia and Poland. In 2016, it achieved revenues of $16m — 54% higher than in 2015. This number is expected to grow to roughly $20m in the current year, with underlying adjusted EBITDA of $2m. Sperasoft’s enviable list of clients includes Electronic Arts (developer and publisher of top sporting titles including Fifa), Ubisoft (maker of newly-released Assassin’s Creed: Origins), Warner Bros and Riot Games.  

Trading on a nosebleed-inducing valuation of 58 times earnings for the current year (reducing to 41 in 2018 if earnings growth estimates are hit), Keywords is clearly priced to perfection. 

That said, with the popularity of gaming showing no signs of slowing and the company quickly establishing itself as the global go-to destination for services in the industry, I still regard it as an exception to the rule that hyper-expensive stocks are simply too risky to be worth bothering with.

The company posted a 15% rise in reported revenue to £6.5bn, driven by higher platinum-group metals (PGM) prices and a £179m foreign exchange (FX) benefit. Excluding PGM and at constant FX rates, sales were up 5%.

A strong performance from the company’s Clean Air division (around two-thirds of group revenue) was led by double-digit growth of Heavy Duty Diesel catalysts in every region. And it saw growth in the Efficient Natural Resources and Health businesses. Only the relatively small New Markets division failed to contribute, with sales being little changed from the same period last year.

Technology leadership

With its technology leadership, Johnson Matthey’s Clean Air business is set to benefit from tighter legislation across the world, particularly in China and Europe. Add in its growing pipeline in Health and targeted investment in Efficient Natural Resources and there is a compelling proposition for investors.

Chief executive Robert MacLeod said today: “We are building a stronger platform from which we will achieve our goal of attractive returns to shareholders over the medium term: mid-to-high single-digit earnings per share growth, expanding return on invested capital to 20% and a progressive dividend.”

A current-year forecast price-to-earnings (P/E) ratio of 15.5 and a prospective dividend yield of 2.5% strike me as attractive for the medium-term growth outlook. But there’s also huge potential in the New Markets division, notably in the company’s development of the world’s first cobalt-free battery. This could be a major kicker — a game-changer even — for long-term earnings and dividend growth. As such, I rate the stock a ‘buy’.

Eyecatcher

Also in the industrial chemicals sector, FTSE SmallCap firm Zotefoams (LSE: ZTF) is a company that’s caught the eye this year, with its shares having risen by as much as 58%. The business rightly deserves investor attention, in my view. It uses a unique manufacturing process of environmentally friendly nitrogen expansion to produce a range of foams — including lightweight, high-performance and advanced insulation — which it sells into diverse markets worldwide.

A Q3 trading update earlier this month, in which management advised that full-year revenue is expected to be ahead of market expectation and profit at the top end of the range, is indicative of the strong demand for the Croydon-based firm’s products and its increasing penetration of international markets.

At 375p, the shares have eased back from their post-trading-update high of near to 400p. The current-year forecast P/E is still relatively high at 24 but it falls to 21 next year and I see the long-term growth prospects as highly appealing. I also expect the current modest dividend (the yield is 1.6%) to advance strongly with earnings growth in the coming years and this is another stock I also rate a ‘buy’.

Wey Education (LSE: WEY) shareholders should be sporting cheesy grins today after their shares spiked up by more than 80% in just two days — from a low of 17.5p on Monday, they reached 32.7p during Wednesday morning trading.

Wey, which has been in its early cash-burn days, has just posted news of its “maiden profit before tax of £17,630“, for the year ended 31 August. That might not sound a lot, but there could be far more to come.

It floated on AIM as recently as December 2015 and runs “the UK’s only online fee-paying secondary school,” InterHigh, so it’s a bit of a niche stock and you really need to know what you’re doing — but the figures do look good.

Start of something big?

Turnover for the year rose by 60% to £2.4m, with the company’s B2B division, The Wey ecademy, “experiencing significant growth” and we were told to expect significant further turnover rises in the current year.

The B2B business has “already exceeded the target number of pupils” expected by the company, and that does emphasise the current demand for online learning.

I’ve been impressed by how well Wey’s secondary school offering is doing at this early stage, as I would have expected demand to build more slowly — but I have no doubt of the potential for business-related online education.

There are few meaningful fundamentals right now, but if EPS grows as expected, this could be a tempting buying opportunity.

52-week high

Shares in Zotefoams (LSE: ZTF) shot up on Wednesday too, hitting a 52-week high of 393p in response to the company’s third-quarter update.

The firm bills itself as “a world leader in cellular materials technology,” and that essentially means light, padded, waterproof, rubbery things — from trainer soles to aircraft ejector seats. And it seems to be good at it, with Q3 revenue up 22% and revenue for the nine months up 24%.

And what has excited the markets is an upgraded outlook that now suggests full-year revenue should be ahead of expectations with adjusted pre-tax profit at the top end.

Current forecasts suggest a forward P/E of around 26 for the full year, after the day’s share price rise, and the 2018 multiple would stand at around 22.

Growth rating

Those will presumably come down when updated forecasts are available, but we’re clearly looking at a valuation that’s expecting earnings growth to continue — and we have EPS rises of 15% and 17% predicted for this year and next.

Dividend yields are modest at around 1.5%, but they are well covered and the payout is progressive, with rises expected to come in a bit ahead of inflation. Zotefoams isn’t exactly a cash cow just yet, but I do see stronger dividend potential in the longer term.

The share price has been a bit erratic over the past five years, but it’s just about doubled and that’s an impressive performance — way ahead of the FTSE 100‘s modest 34% over the same period.

With international expansion on the horizon thanks to the company’s new factory in the US, and low debt on the books, I see more to come.