I prefer to value companies on their:* normalised profitability...

I prefer to value companies on their:

* normalised profitability (ROE)
* % growth in future cash flows
* management and balance sheet quality

and finally adjusting for risk and market cap (higher P/E for high growth and low risk, lower P/E for low market cap and low liquidity due to difficulty in selling shares on bad news).

Atcor is now highly profitable and improving with a normalised return on equity for FY13 of around 35% using a normalised NPAT of $1.7M (after deleting around $1M for the Government grant and foreign exchange gains). Normalised P/E was around 12 at the current share price of 13.5cents.

Atcor is now relatively low risk, having strong patent coverage, market leadership, proven management quality (growing margins at the same time as 39% sales growth), strong research paper support, and approvals for sale in many major markets. On its balance sheet, it has no debt, cash of more than half its equity, and current receivables well in excess of current liabilities.

Given the likelihood of near term reimbursement coverage in the USA, wider application in medical trials for other medical conditions, growing penetration of the specialist market and likely registrations of the new XCEL in the Asian markets, I assume that average sales growth should easily exceed 25% per annum for several years to come (it was 39% in FY13). All of these factors would point to a P/E of 25 or more for a large company. Given Atcor’s low market cap and low turnover, I would discount the P/E by one quarter to around 19.

That gives a current valuation (for me) of around 21 cents, which should continue to grow by 25% per year, assuming my growth rates eventuate. This translates to a valuation of around 41 cents in 3 years, around triple the current price.

Atcor won’t be paying tax for a long time yet as they have accumulated losses of over $28M. Their high level of cash, low requirements for reinvesting capital (only $58,000 last year) and high return on equity mean they need to start paying dividends soon. However if they do need to increase investment in manufacturing capacity or marketing I would not mind as this will only result in profits increasing even faster than I estimate.

I don’t think it will be a smooth rise to triple the price in 3 years. Before the market truly recognises the value in Atcor that I have outlined above, it will need to first deliver on the following:

1. Evidence of wider application to drug trials for other conditions (e.g. cancer) and growing penetration of the specialist market;

2. Signing of 1 or 2 US payers in the USA to enable automatic reimbursement;

3. XCEL registration in Korea, Singapore, China, Japan (XCEL was approved for sale in Taiwan in March 2013 and USA in November 2012; it is already approved for sale in Europe, Australia, India, Malaysia, Indonesia).

Until these milestones happen, it is entirely possible that the Atcor share price could continue its past habit of rising rapidly on good news and then drifting back down on no news.