Does Kromek Group represent good risk and reward for investors?

Does Kromek Group represent good risk and reward for investors?
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With 200 patents to their name, you would think Kromek Group represents good risk and reward on a market valuation of £77m.

 

But, there is a problem with assuming “number of patents” equal success.

 

That is sales generation.

 

Last year, Kromek Group has generated sales of under £10m. Costs aren’t far behind coming in at £12.7m meaning it made a loss.

 

In fact, it has only seen losses.

 

Management’s Promise

However, Kromek’s management is hopeful things will pan out for the better with a promise that EBITDA will breakeven during 2017/18, caused by a “step-change” of 40% in sales.

 

Putting it into Perspective

Currently, Kromek is making £1.5m in EBITDA loss and £3.8m loss before tax.

Although a breakeven EBITDA is progress, it’s would still mean a net loss on paper.

To reaffirm this loss is real, the forecast 40% sales growth = £12.46m. Still less than last year total expense of £12.7m.

Also, expect total costs to rise along with rising sales.

 

Shareholders are comforted by Kromek’s £16.2m cash balance.

 

The Risks Shareholders are taking with Kromek Group

The latest interims won’t paint the whole picture of Kromek Group.

We need to go in-depth and study the company’s Financials.

 

And there are a few investors and shareholders alike must take notice.

 

First, is the build-up of capitalising development costs. These aren’t expensed but regarded as assets because it helps to generate future sales.

And Kromek is ONLY measuring sales, not profit generation. This is good for Kromek because sales pay the bills.

 

But, it’s bad for shareholders if they want to get a return on their investment.

 

The rise in capitalised development cost has grown faster than sales.

 

So, the stakes are high.

 

Second, the cash burn of Kromek Group

 

The average annual cash burn of Kromek is around £6m and since 2011, the total cash burn is £37.7m. But the company is able to raised £53m from investors.

 

An annual cash burn of £6m would mean current cash balance would take it past 2020.

 

Understanding Kromek’s Market Capitalisation

 

The market value of Kromek rose from £55m in 2014 to £74m. Meanwhile, the shares didn’t rise but fell to 27 pence, due to higher shares outstanding.

 

With a £74m valuation, the market is pricing in a minimum £3m to £4m net profit, before it even happened.

Well, we the market opportunity is around £800m.

 

The RISK and REWARD of KROMEK

At £74m, investors are paying a lot for a business that needs to prove themselves.

Any failure will lead to massive losses, especially capitalised costs write-downs. Also, a fundraising is needed to continue as a going concern leading to share price dilution.

At the end of the day, failure would mean a 75%-80% fall in the share price over three years.

 

What if Kromek is successful?

In that case, my market capitalisation projection would rise to £150m-£200m. By then the share price would be higher, but how high will depends on further share issuances and new borrowing.

 

On balance, I put the risk: reward ratio at 75:25.

 

Final Thoughts

The next few years will be crucial for Kromek because it will determine if the share price will rise by 100%+ or collapse by 80% or more.

As of today, Kromek could go either way, but I feel next year is super crucial and we will either see success or failure.

Either way, shareholders will face tense moments.

 

 

Thank you for reading. If you enjoy the article, then please share it on your social media and email.

 

DISCLAIMER

 

The above analysis is based on my opinion and nobody else. It does not constitute professional investment advice. Data is correct on at the time of availability.  I don’t hold the company’s shares unless stated.