This ‘special situation’ stock looks set to fly

Medical diagnostics specialist EKF Diagnostics Holdings (EKF) released full-year results today that show a blistering turnaround in financial fortunes.

Out of the red and into the black

Headline figures include a surge in revenue of 28% compared to 2015’s outcome,  with gross profit rising by 24%, and adjusted earnings before interest, tax, depreciation and amortisation (EBITDA) of £6.1m, which trounces the loss of £0.3m suffered the year before.

This stellar performance shows in cash from operations, too, with the firm delivering an inflow of £8.8m, which compares to an outflow of cash during 2015 of £2.9m.  On 31 December, cash on the balance sheet had grown 300% for the year and stood around £7.9m, translating to net cash of £2.2m — a vast improvement on the net debt figure edging towards £9m we saw a year ago.

By most measures, this is a good financial performance that marks a turnaround in the firm’s fortunes into profitability. The shares have responded well, soaring more than 130% since February 2016. However, I think there could be much more to come for investors because the firm also announced today that it is evaluating plans to split the company into two separate entities, with the aim of achieving a fair reflection of the value of each separate business.

The parts could be under-valued

EKF Diagnostics describes itself as “a global medical diagnostics business with a long history in point-of-care testing and central laboratory manufacturing“. The firm makes HbA1c analysers and glucose analysers used by doctors, sports clinics and diabetes clinics, and distributes them to more than 100 countries.

The directors put today’s positive results down to a restructuring programme aimed at driving profitability and organic sales growth. Non-executive Chairman Christopher Mills reckons the firm moved fast to turn things around and predicts “continuing benefits” for shareholders during 2017.

I think the business separation idea is interesting, and demonstrates that the directors are focused on investor returns as much as they are on turning around and growing the business. The separation would divide the business based on the existing departments of Point of Care and Lab Diagnostics. The directors believe that the parts of the business are worth more than the firm’s overall valuation implies and separating them into stand-alone firms would give the opportunity for valuations to adjust in a way that may add to investor total returns.

Slight complications?

Around 39% of sales came from the US during 2016 and that leads to a challenge regarding tax implications surrounding the proposed split. To overcome this problem the directors plan to cancel the company’s shares from trading on AIM, followed by the pursuit a listing of the shares of both companies on a “market to be determined.”

Recognising that a period of being unlisted on a stock exchange could be uncomfortable for shareholders the directors are considering offering a 21.5p-per-share buyback prior to splitting the business for those who would rather exit their holdings than go through the changes.

With the share price sitting around 19.25p as I write, there’s a potential 2.25p immediate upside to get to the directors’ implied valuation, which, on top of the ongoing turnaround and growth trajectory of the business, adds to the attraction of the stock, in my view.