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Stockwatch: How to play this AIM tech share

14th September 2018 11:19

Edmond Jackson from interactive investor

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It's had a chequered past, but this 'small beast' has great potential, believes companies analyst Edmond Jackson who gives a steer on what the right investment approach might be. 

Does a spike in the AIM-listed shares of wireless systems group Filtronic signal capability to leverage value for a near-£50 million business? Alternatively, is this merely speculation on small-cap tech shares in a late-stage bull market, hence liable to plunge once liquidity preference kicks in?  

It's a typical dilemma where cautious investors can end up regretting selling too soon; but how do you know if a new chapter in a company's history will prove financially exciting or if it’s mainly driven by hope?

New antenna grasps imaginations

Filtronic has entertained investors with varying technologies for over 20 years, its penny stock status nowadays – currently around 22p – comparing with my recollection of over £20 at the peak of the 1999-2000 tech boom.  

More recently, the 2015 financial year brought losses as demand from the original equipment manufacturer (OEM) customers Filtronic serves, fell short of expectations.  To a large extent this company is at the whim of such OEMs following shifts in global trends but, if the timing is right, then profits can swing nicely.  

Its latest technology gobbledegook is "Massive MIMO" (multiple input/multiple output) antennae for 5G rollout where a full grasp of what's involved is frankly unnecessary; the crux being the extent of global roll-out for this next generation of wireless capability and what extent of profit can emerge for Filtronic.  

The story is quite easily latched onto by investors. It originated last April in an RNS announcement about collaboration with Nokia based on Filtronic proprietary designs, significantly increasing network capacity thus "a compelling business case for mobile network operators... a major step in the development of dense 5G networks". 

Financial upshot remains speculative

Scope for scaling up as 5G capability evolves makes for tantalising figures: Nokia will supply T-Mobile with £2.7 billion of network equipment as part of T-Mobile's first nationwide 5G rollout in the US.  Meanwhile, the financial upshot for Filtronic and how long it might last before some other technology advance is highly speculative.  

Filtronic declared initial production orders for its Massive MIMO antenna product in early August, then at the month-end a deal with a major European manufacturer. Altogether, it’s £2.4 million of revenue or about 10% of recent annual total.  

Over six weeks the stock has doubled from about 11p to over 23p, adding £22 million in market value, although an analyst at Panmure Gordon, Filtronic's broker, has yet to raise forecasts.  Flat earnings per share (EPS) of 0.6p is projected from 2018 to 2020 despite some Massive MIMO orders being fulfilled this financial year, since revenues from legacy filter products will correspondingly tail off. However, it does admit that "we now believe our forecast for the 2020 financial year may prove conservative." 

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The market is seeing through this to reckon Panmure is being prudently cautious like it should as company broker, otherwise raising hopes which could create a rod for its client’s back.  But if Massive MIMO technology gains further acceptance, then revenues from 2020 onwards should be interesting. 

Potential was evident a year ago

I drew attention last September at around 12p a share, with the rationale that key elements of a turnaround had been achieved after Filtronic had slumped into losses (see table).  4G rollout was proving a driver with management preparing also for 5G as IT hardware becomes integrated, where "Filtronic is well placed to play a part in this major market development."  

Elsewhere, we had a £4.8 million supply deal with a major European defence equipment manufacturer, buttressed revenues, and investment in international sales & marketing contributed to "a growing opportunity pipeline".  I thought the market was barely noticing the industry positioning, thus Filtronic rated a steady "accumulate".  

Its stock rose to 16p by end-2017 though had halved near 8p, mid-2018, showing how sentiment can be fickle despite no adverse news.  Presently, there's some doubt about whether the boom in Nasdaq stocks can hold, and whether a shake-out must follow. 

However, tech specialists say it will more likely encourage better stock selection, although you might argue that "they would say that, wouldn't they," if tech is broadly in a late-stage bubble.  Doubtless the telecoms industry will advance whatever prevails in the stockmarket, though it remains to be seen exactly what Filtronic reaps from 5G. 
 

Source: interactive investor (*) Past performance is not a guide to future performance

Revenue guidance understandably vague

In its end-August contract announcement, management said that Massive MIMO demand would follow customers' normal buying cycles, hence there will be no further "new order" announcements unless outside the expected pattern or being material relative to expectations.  

"There is no certainty that production orders will continue at the current rate" (i.e. two in a month), although such a caveat was likely insisted by advisers for prudent caution.  Notably, the chief executive concluded how this current product is "the first offering from our Massive MIMO antenna range" describing the technology as "key to the densification of 4G/LTE networks and a cornerstone for future 5G networks."

Quite rationally the market is factoring in hope value until Filtronic either beats or disappoints it, and it remains to be seen whether over £20 million on the market cap risks exuberance.  As yet, the financial upshot is impossible to reliably predict. You have to decide your risk preference, whether to hold or manage a position, or with fresh money wait for current interest to ebb.  

Filtronic - financial summary         Broker estimates
year ended 31 May 2015 2016 2017 2018 2019 2020
             
Turnover (£ million) 17.5 13.6 35.4 24.0 24.7 25.5
IFRS3 pre-tax profit (£m) -11.0 -7.0 2.2 1.2    
Normalised pre-tax profit (£m) -10.8 -6.5 2.1      
Operating margin (%) -61.7 -47.7 4.8 5.0    
IFRS3 earnings/share (p) -10.2 -3.2 1.5 0.6    
Normalised earnings/share (p) -9.9 -2.9 1.5 0.6 0.6 0.6
Price/earnings multiple (x)       36.7 36.7 36.7
Cash flow/share (p) -3.6 -3.2 1.7      
Capex/share (p) 0.4 0.3 0.4      
Net tangible assets per share (p) 5.0 2.2 3.5 4.0    

Source: Company REFS      Past performance is not a guide to future performance

Broadly a 'hold' stance

A general stance for enterprising investors would be 'hold', for if this new series of antennas proves the industry standard in a substantial roll-out, there’s little point trying to out-guess volatility, just tuck Filtronic away.  

A more conservative stance would be: you can’t be reasonably sure what financials will ensue or if technology will move on, so when presented with a chart spike use it to lock in some gains –  taking out an element of initial cost.  

An RNS cites Cannacord Genuity reducing its equity exposure from 10.5% to 9.2% on 10 September on behalf of discretionary clients.  Who knows if Nasdaq might crater one day or Filtronic be challenged to grow into its market valuation.  

Small beast to put hairs on your chest

More positively, the price/earnings (PE) ratio could drop nearer a standard growth multiple around 20 times if revenues ramp up, so if markets turn jittery then Filtronic is well worth watching as a fresh buy.  

Mind the company's long-term history has involved plenty of high hopes being dashed - as recently as 2013-15 the stock fell from an 80p range to below 5p.  This goes with an industry of classic "creative destruction".  Filtronic is a small beast nowadays but can still put hairs on your chest.  Hold.

*black lines show levels of previous technical support and resistance.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company’s or index name highlighted in the article.

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