Is the honeymoon over?, page-9

Fair value depends. You can’t really value a company with a negative EPS which is why small caps are typically volatile and uncertain. The entire venture capital field is quite qualitative compared to investment banking because start-ups are usually making a loss. You can attempt to forecast cash flows and run a DCF or use those forecasted cash flows to do a simple PE ratio analysis which I will do quickly for you.

I used to work at Morgan Stanley and am a big fan of their valuation approach in which they have a base case, a bear case, and a bull case. Noting that the research team at MS is consistently rated as one of the best in the APAC and Asia region.

Base Case

If you take a linear approach to their cash flow generation, they increased cash receipts by $3M this quarter to sit at around $350k profit which suggests $12M profit in 1 year time. At 300M outstanding shares, you have an EPS of 0.04.

Now running a scenario analysis at a range of PE ratios: (Ref: http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/pedata.html)

P/E = 15 (ASX average, suitable for a mature company)
Price = $0.60

P/E = 22 (Russel 2000 average, suitable for small caps)
Price = $0.88

P/E = 29 (Chemicals sector average in the US, remembering that AJX’s operations are based in the US)
Price = $1.16

Bear Case

To find a baseline, another way to look at it is to take the company’s 40% gross margin target and add the revenues we know about. So if we take the annual report’s revenue of $24M and add $13M from Pegasus, we get a basically confirmed $37M revenue (noting in the webcast they said they have 100% retention of customers). At 40% margin, that’s $14.8M, minus $11M of expenses for an EPS of 0.0127. As these revenues are all but confirmed, this is a MINIMUM value which represents the lowest price the stock should possibly be worth at this very moment in time – it’s not forward looking and assumes the business doesn’t grow at all.

Running the same scenario analysis:

P/E = 15 (ASX average, suitable for a mature company)
Price = $0.1905

P/E = 22 (Russel 2000 average, suitable for small caps)
Price = $0.2794

P/E = 29 (Chemicals sector average in the US, remembering that AJX’s operations are based in the US)
Price = $0.3683

Bull Case

I’m going to skip this because I think everyone’s had enough talk of blue sky and potential. I do believe there is still massive potential, it’s just taking a lot longer than originally expected. For example, when I bought in 2 years ago it sounded like regulatory tailwinds were imminent, however, we’ve only just now seen regulation change in Alexium’s favour (better late than never). However, keep in mind that the FR market is HUGE and if all players in the market suddenly find their products out of regulatory favour, AJX might explode. Hint hint – in the previous webcast they suggested that while Alexicool is the main source of revenue, FR will eventually dwarf it. I wonder why?

Conclusion

Now does it look like the stock is massively undervalued? Yes, it does to me, which is why I’m still holding a ~40-50% loss. Why is it undervalued? It looks like the market is not convinced that the company can achieve the revenue/profit/EPS mentioned above. After a few consecutive quarters of increasing profits, sentiment will turn around quickly.

I feel like price volatility is consumed by short-term speculation. People are jumping at shadows. Oh no, announcements look different – what does that mean? Oh no, revenue growth has slowed – what does that mean? Oh no, the CEO retired – what does that mean? Oh no, there were pictures of planes in the presentation – what does that mean?

Stick to the facts and the numbers, they don’t lie. If you’re a long-term, fundamentals investor like Buffett, stop panicking. If you’re a short-medium term retail investor who isn’t sure what they’re doing, I can understand why you’re panicking since you're just watching the share price (this kind of crowd mentality is what drives market bubbles and crashes). If you’re a short term tech trader, you’ve probably already made a killing on the volatility.