Investing in the world of penny stocks can be risky. After all, most of the time, a share price is low for a good reason. But every so often, among these companies, a hidden gem can be found that can lead to explosive returns.
I’ve found one particular penny stock whose share price dropped 60%+ in 2020 — from 28.8p to 11.5p. But since January, it has been climbing and is now back to around 13p. Is this the start of an explosive recovery? Let’s take a look.
A leader in equipment rental
HSS Hire (LSE:HSS) is a leading provider of tools, equipment, and related services with more than 32,000 customers across the UK. The business has two segments.
Its tool & equipment rental division is responsible for generating approximately 70% of total revenue. As the name suggests, it buys, maintains and then leases equipment out to its customers. A lot of apparatus in the construction industry is relatively expensive. So, renting the tools required for specific jobs is quite common. At the end of 2019, the UK equipment rental market was worth around £4.7bn, growing by roughly 4% each year.
The second division is its customer services. This ultimately has two roles. The first is to find and recommend which tools to use for different jobs (including those not provided directly by the firm). And the second is to offer training courses for using specific equipment. This ensures the user’s safety while simultaneously building stronger relationships with customers.
What’s happening with the share price?
The pandemic has created a challenging operating environment for many construction companies. And that has directly impacted HSS Hire’s business. Total revenue and underlying profit for the first half of 2020 fell by 22% and 38%, respectively, pushing the firm back into the red.
So it’s not surprising that the share price lost 50% of its value over the past 12 months. But now that the vaccine rollout is underway and lockdown restrictions are slowly being eased, HSS Hire could be back on track. City analysts have forecast that the performance in the second half of 2020 will push total revenue up to around £335m. That’s only around 2% growth versus 2019 — not exactly exciting. But because the share price crashed, assuming the revenue forecast is accurate, the penny stock is now trading at a P/S ratio of 0.27!
Given that the average P/S ratio of the UK market is around 10, that looks like an absurdly low share price to me.
The penny stock has its risks
As with all public companies, and penny stocks in particular, there are always risks to consider. Due to the low barriers to entry, the equipment rental industry is highly competitive and fragmented. HSS Hire does have a well-known brand but with so many competitors, its rental fees are continually under pressure.
Consequently, customer retention is a vital aspect of its business that lives and dies with its customer service. Suppose the quality of these services begins to wither. In that case, since the lease agreements are short-term, customers can simply go to another equipment provider without incurring any switching costs.
These risks are a bit too high for my portfolio. But I can’t deny that the share price looks incredibly cheap. Therefore I would not be surprised to see a rapid recovery in 2021. However, whether the business can grow from there remains to be seen.
Zaven Boyrazian does not own shares in HSS Hire. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.