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BUY: PureTech (PRTC)
A share price recovery has restored PureTech’s lustre, while the subsidiaries are still pouring out cash, writes Julian Hofmann.
Biotech investors seem to have discovered some of their appetite for risk over the past few months — the biotech sector, generally, was one of the first to de-rate in advance of the technology collapse. However, the market seems to be tentatively looking for value in biotechnology, the net result of which is that PureTech can sit out the long wait for its clinical results with a degree of confidence in its equity and funding position.
The company’s sprawling drug pipeline encompasses everything from irritable bowel syndrome to oncology medicines to treat solid state tumours. Meaningful data readouts won’t be before the end of 2023, so investors merely need to sit on their positions and wait for something to happen.
The positive is that PureTech is still attracting both equity investments into its subsidiaries, more than $113mn (£95.7mn) in the half, while post-period the company received $115mn from share sales in its Karuna subsidiary. In total, the Karuna initial investment of $18.5mn has now returned an astonishing $681mn for PureTech. In addition, another subsidiary Akili, listed on Nasdaq, raised a further $164mn. The increase in liquidity also made it easier for management to announce a $50mn share buyback alongside these results.
PureTech sits on plentiful cash reserves and has a clear runway to develop meaningful data next year as its internal development pipeline is now fully funded by its subsidiary businesses. With losses predicted for some time yet, a meaningful valuation is awkward, but broker Peel Hunt believes the cash generated from its spinout companies alone covers the current share price.
SELL: RM (RM.)
The education specialist is struggling with an expensive IT project, writes Jemma Slingo.
On the face of it, conditions are favourable for educational resource provider RM. Schools and nurseries are open, examinations are back and — recession or no recession — children will always need learning materials.
The group, however, has had a difficult six months, with none of its three divisions achieving profit growth. RM Resources — which supplies physical resources to schools and nurseries — increased sales by 7 per cent, but struggled with high freight costs and shipment delays. As a result, adjusted operating profit more than halved to a meagre £1.2mn, from revenue of £51.6mn.
RM’s assessment arm — which provides online testing services — was similarly disappointing. While sales grew by 17 per cent, adjusted operating profit sank, due to “higher costs in the short term” associated with software development. An expensive, group-wide IT programme is also “proving more challenging than anticipated” and is weighing on margins.
The group’s main problem seems to be its technology arm, where revenue fell and adjusted operating profit dropped by 47 per cent. RM has appointed new leadership in the division in a bid to turn it round. However, it warned that the project “will take time and profit recovery will lag revenue growth”.
RM’s level of debt is also setting off alarm bells. Net debt has almost quadrupled year on year to £41.5mn due to the “challenging” IT project. As a result, dividends have been suspended and RM’s banking partners have increased their net debt / adjusted Ebitda ratio covenant from 2.5 times to three times for the May and November 2022 period end tests.
This, in turn, has warped RM’s balance sheet: the leverage extension means borrowings have been reclassified as current liabilities, and the group now has £43.8mn of debt that — in theory — is due within a year. Management stressed that lenders “have made clear they currently have no intention of accelerating all or any part of the loan repayments” and borrowings are expected to revert to non-current liabilities at the end of November.
What will happen if RM’s financial situation worsens, however, remains to be seen.
Analysts at Peel Hunt identified “some green shoots”, including strong international growth in RM Resources, and noted that the dividend policy will be reviewed ahead of the group’s preliminary results. Meanwhile, the shares dropped by 44 per cent following the results announcement, meaning the stock is cheap.
That’s not enough to tempt us, though.
HOLD: Wood Group (WG.)
The energy services and engineering group is looking to upcoming divestment to clear its debt pile, writes Alex Hamer.
A year into this supply-constrained, high-demand period for oil and gas, Wood Group has remained heavily indebted and dividend free. The group thinks its focus on cash generation will bear fruit, though, and the sale of its built environment consulting division for $1.6bn (£1.38bn) should knock off the debt issue.
Helpfully, its lenders increased their covenants so hitting a net debt-adjusted Ebitda ratio of 4.2 times did not bring the cavalry running at the June measurement date. Wood said the built environments sale cash should come through by the time the covenant goes back to 3.5 times.
Investors will get a clearer picture of the group under new chief executive (and former chief operating officer) Ken Gilmartin, who took over the top job last month, once the group’s new strategy is released in November.
He said his first weeks in the role had come at a time of “improving operational momentum. The strong order book gives me confidence for the future but there is a lot more to do on cash generation,” he said.
The group has already started a move away from large-scale projects and this hurt sales for the period, although the operations unit overtook projects to become the biggest contributor in terms of revenue, at $1.2bn.
The idea behind taking on fewer lump-sum projects is to smooth out revenue and avoid contracts that end up being lossmaking.
That doesn’t mean new deals haven’t come in group-wide — Wood signed a decade-long “engineering and project support” agreement with Chevron, as well an extension with Equinor for work on its North Sea operations.
In the first half, there was a free cash outflow of $363mn, driven by a $208mn working capital outflow and exceptional costs of $102mn.
This last figure included $38mn in payments after a Serious Fraud Office probe into 2017 Wood acquisition Amec Foster Wheeler, with another two payments of a similar size to come.
Another regulatory headache that has popped up this year is around a former Amec project, a chemical plant in Texas. Enterprise Products is after $700mn from Wood, and the group said a verdict was expected by year end. A settlement could still be reached, however.
Analysts are forecasting a small final-year dividend, on earnings per share of 19 cents, although the consensus has become more pessimistic as the year has gone on, falling from 26 cents a year ago. While investors aren’t feeling the energy rush yet, we stick with our hold call on the basis of the balance sheet improving and massive project losses now hopefully a thing of the past.
Hermione Taylor: A closer look at inflation and hedonic pleasures
The UK’s double-digit inflation is inevitably making headlines. Most analysis looks at the big picture: how the rising price level impacts incomes, investments and economic stability. But inflation figures deserve a closer look — and calculating the ever-changing prices of the ever-changing versions of the ever-changing products bought by UK consumers is no easy task.
The Consumer Prices Index (CPI) is the UK’s key inflation statistic, designed to measure changes in the prices of things that consumers regularly purchase. Inflation is calculated by the Office for National Statistics (ONS), which constructs a statistical shopping basket consisting of the hundreds of goods and services bought by a “typical” household.
Deciding what a “typical” household buys is the first challenge. The contents of the basket of goods changes each year, and acts as a brutal barometer of what’s in and what’s out. This year saw atlases and dictionaries removed as “the rise of the internet has seen the need for reference books fall”. Pet collars were added to the basket “to reflect the growth in pet accessories linked to the increase in pet ownership more generally during the pandemic” — as were antibacterial surface wipes.
The contents of the basket is also governed by practicality. Prices for many items are still obtained by local agents, who visit stores in person to collect over 100,000 quotations each month. Vegan sausages, which were added to the basket this year, had the advantage of “reflecting the growth of vegetarianism and veganism”, while also being widely available in supermarkets for price checking.
As well as keeping track of changing tastes, the ONS must also keep pace with evolving products. Technological progress means that goods such as laptops and PCs have developed rapidly over the past decade. If the ONS focused only on changes in price, it would miss product improvements and risk overstating inflation. To tackle this, it uses something called “hedonic adjustment”. The term has Greek origins (“of or related to pleasure”), and aims to reflect the fact that while some products might cost more, they have also got better.
Performing hedonic adjustments is a remarkably abstract process. The ONS uses regression analysis to determine the value of the “utility” derived from each of the characteristics that constitute an item. A PC, for example, would comprise the following: monitor, processor speed, hard drive, memory and video card.
The ONS gives the example of a new PC, which replaces the model currently used in the CPI basket of goods. The new model costs 15.8 per cent more, but has a faster processor speed. It looks as though PC prices have increased significantly, but the situation is complicated by the fact that the new, improved product also offers higher utility. Hedonic adjustment aims to accommodate this: once adjusted for quality improvement, it suggests that the price of a PC has in reality fallen by 2.2 per cent.
The process has its critics. Andre Ratkai, president of US investment firm Praxis Advisory Group, notes that people have to buy whole items (not just individual characteristics), meaning there is no escaping the fact that these items now cost more — improved or not. He concludes that while hedonic adjustments may accurately reflect productivity increases, they don’t accurately reflect the cost of living.
Hedonic adjustments are more widely used in the US (where CPI calculations adjust 33 items), after an influential report in the 1990s suggested that failing to adjust for quality was pushing inflation up by 0.6 percentage points each year. But performing these adjustments is a laborious process, and they are applied to just a handful of goods (smart watches, PCs, laptops, pre-pay smartphone handsets and tablet PCs) in the UK.
The impact of technological improvements on today’s inflation figures is being drowned out by soaring prices for energy and imported goods. Yet we spend so much time talking about inflation figures that it is important to take close looks at how we arrive at them.
Hermione Taylor is an economics writer for Investors’ Chronicle
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