Two UK small cap shares that have reported results today that caught my eye. First up are Diaceutics (LSE: DXRX) shares for which results results for the full year ended 31 December, 2022 became available. Revenue increased to 40% to £19.5m, missing analyst consensus of £20m. But, bear in mind that revenues were £4.6m in 2016. This company is growing fast.
It is now generating 35% of its revenues via subscription, compared to 3% in 2021. The order book has inflated from £16.9m from £1.8m in 2021 with £10.9m of that expected to be realised in 2023. There is £19.8m of cash and cash equivalents on the balance sheet and zero debt. The net change in cash was slightly positive in 2022 which is better than the £5m outflow in 2021.
That all looks pretty good to me. It’s a growth company. Although profits are not necessarily expected the net profit margin is basically zero, and the price-to-earnings (P/E) ratio is well over 100. But, more than that operating margins are weak or negative, if that makes sense to say, and they have deteriorated since 2016.
The only issue I have is that getting an idea of what this company actually does is difficult. The explanations from the company are, I think, inscrutable. It has its DXRX platform, which generates revenues via Insight Solutions (Data) and Engagement Solutions (technology enabled services).
But the descriptions of these services leave a lot to be desired. And working out what they do is important as the DXRX platform generated 76% of the revenue compared to 60% in 2021. The advisory revenues the company also reports are losing relevance.
Insight Solutions (formally referred to as Data) comprise access to the DXRX platform diagnostic testing data repository to utilise licensed data insight products, typically: lab segmentation, physician segmentation, testing rates tracker and physician signal.
Engagement Solutions (formally referred to as Tech-enabled services) are comprised of a suite of services designed to solve the challenges affecting precision medicine commercialisation success at a regional and global level, such as: Lab alerts, Lab training, Lab engagement and Physician engagement.
Diaceutics annual report, 2022
I don’t like difficult to interpret corporate or marketing buzzwords nor technobabble in general. I especially don’t like it in reports to investors. Shareholder engagement should not be an exercise in showing how smart we all are. Descriptions should be clear, and in plain language. The point is to explain to your investor base what you do, how you are doing it and how well its going. It is not about erecting intellectual walls and baffling people into being believers.
Diaceutics enabling precision medicine
So, here’s what I know. A patient suffering from cancer might get a form of chemotherapy, as will lots of other suffered. However, this patients tumour might be significantly different from the rest. Precision medicine would allow the particular characteristics of this tumour to be identify and the treatment tailored to better kill it.
Now, the days of every patients getting a medicine made to order for their particular condition are not here quite yet. But, we can divide thousands of patients with say, lung cancer, into different groups, and give the groups a different and proven to be more beneficial treatment, rather than treating everyone the same.
Putting patients into groups is usually done by identifying specific ‘biomarkers’ that the tumour displays that other patients tumours lack, or vice versa. The biomarkers might be found with blood tests, or by looking at the tumour cells themselves. It’s not just cancer that precision medicine can help with, but I like to take every opportunity to discuss how we might eradicate this disgusting disease..
Diaceutics does not make drugs, run labs or do tests, not does it administer treatments. It appears to be able to find labs that are capable of running and including a test for a biomarker, at sufficient scale, for a pharmaceutical or biotech company to build a subset of patients that should benefit from its treatment. It can supply drug makers with information about what doctors are running what tests for which biomarkers. That would allow the drug makers to only target those doctors that are interested in the biomarker their drug is designed around.
Surface Transforms
Brake disc manufacturer Surface Transforms (LSE: SCE) also reported preliminary results for the year ended 31 December 2022 today. Now, I am going to have to report a possible conflict of interest here. I owned Surface Transform shares. I sold them at a decent profit about a year ago after they blew up after the coronavirus market crash. I thought that was over done, took the opportunity to get out, and they tumbled after…lucky me.
But, I remain frustrated by this company. It always seemed to be on the verge of something, yet, never fundamentally turned the corner when I was a shareholder. Perhaps this time its for real though. Revenues up 116% to 5.1m in 2022, missing estimates of £5.6m. But the company now has a customer base of ten original equipment manufacturers (OEMs), which are mid- to upper-market car makers. Three of them are due to generate revenue in 2023, and five in 2024.
The company did report another full year loss of £4.8m, which was larger than the forecast loss of £3.6m. But, analysts are optimistic about the future. They are pencilling in £18.4m of sales in 2023 as ramping up production for one (OEM 8) is said to be game-changing.
Hit the breaks
I have read that word “game changer” in Surface Transforms reports for years, and now it irks me. I used to read it about getting supercar makers signed up. Now, I note that super car exposure is minimal. This company that makes next generation carbon ceramic break discs, which are said to be “The ultimate braking performance for road and track”. This is not a mass market product. But the company looks to be targeting a broader slice of a small market, roughly corresponding to performance and luxury cars. It has now increased its factory floor print and is ready for higher volume production. Given the string of losses, modest debt level increases, and the fact the share count rose from 59m in 2016 to 204m in 2022, it’s clear how this was paid for.
The latest revenue results are a 20-year high water mark. And, as mentioned analysts are producing optimistic revenue forecasts for 2023. There is a lot of speculation that OEM 8 is in fact Tesla. The description of the manufacturing process used by Surface Transforms, and what Tesla is saying seems to fit. And I have some suspicion that this is driving that optimism. But, Tesla does not fit carbon ceramic breaks as standard, they are optional extras, on some models. Again, this is not a mass market product that Surface Transforms is selling. Its breaks would cost about about 15% of the price of suitable Tesla models if fitted.
Surface Transforms shares
But, say the analysts are correct about the revenues, and they are indeed imagining its Tesla. Would this be a game changer? If their earnings forecasts are correct then then for the first time in its two decade history the company will report a profit of £2.98m. At the end of 2022 it had 204m shares in issue. Assuming this does not change and then 2023 earnings per share will be 1.46p, and with the Surface Transforms share price at 35.2p, the forward P/E ratio is 24. That seems reasonable. I don’t think investors can ask for much more than that.
Surface Transforms says there is one monopolist supplier in its market that generates about £160m of revenues per year. Now, in the UK monopoly power is said to exist when a firm has more than 25% of the market—there are very few pure monopolies anymore. So, the minimum size of the this market must be £640m. Surface Transforms reckons it could be worth £2bn someday. I think that is overly optimistic, and no time frame is given.
Carbon ceramic breaks perform better than iron ones, and they are lightweight, which dresses efficiency concerns. However, iron disc systems take about 90 mins to make and carbon ceramic ones can take days to weeks. Carbon ceramic breaks are much, much more expensive. To increase the market size from £640m to £2bn would surely require some massive technological change to reduce the cost so they can be realistically fitted as standard in more models.
So lets stick with the more reasonable market size estimate for today and assume minimal growth, perhaps more in line with long term inflation trends. The current factory is good for good for £50m of revenues. That would be an 8% market share in the short term. Space is available for £75m with further investment. That increases share to 10%. But, this is a small market with about five major players, one of them is Surface Transforms and one is that dominant force. This is not a fragmented market. The others will notice if one is hoovering up sales.
And how much of the increased revenues will translate to earnings. The gross margin is positive but volatile, and averages around 62%. But, at least the company is profitable here. But the operating margin is negative, and has gotten worse as revenue has increased driven mostly by increasing selling, general and administrative and research and development costs.
So, while Surface Transforms seems to be on the right track now, I still think investors require a great deal of faith. But, that is true of most small low revenue companies that are waiting for the breakthrough.
NOTE: Inclusion of shares for results round-ups depend on them being UK listed companies who are not part of the FTSE 250 and FTSE 100, have a market cap of over £50m, and are neither trusts nor REITs, and where the results are noteworthy, which is I admit deliberately ambiguous.
DISCLAIMER: James J. McCombie does not own any of the shares mentioned. The Storied Investor does not have any beneficial position in any of the shares mentioned.
The Storied Investor 