Having invested in and covered numerous stocks across the Alternative Investment Market (AIM) over many years now, there has certainly been no shortage of those jam tomorrow stocks.
From ground breaking Biotech’s to novel industrial disruptors, an abundance of prospects have been on offer, particularly for investors seeking to hit on the next multibagger.
Sadly, the vast majority of these would-be trailblazers fail to make the grade, despite constantly returning to investors for further funds, where it is fair to say, there is a sizable AIM graveyard that tells much of the story.
That said, there are those that do, after years of hard slog, go on to make it on the delivery front, thus eventually rewarding long suffering shareholders.
One company that I have been following for some time now and have a speculative interest in is Surface Transforms (SCE), which based in Knowsley near Liverpool has been, for want of a better word, knocking around on the market for many years.
Whilst it has, throughout its time remained loss making and continued to go back to the market for further funds, I believe that right now, the business could really be at an exciting inflexion point.
It’s an often-used adage and I can hear the sceptics pointing out that they’ve heard it all before and what’s new.
As, like many so-called blue sky stories SCE has certainly fallen foul at times, having to warn on prospects and progress, which has often emerged on the back of previously announced positive news to the market.
Two steps forward one step back is frustrating stuff, which hits on credibility and understandably sows the seeds of doubt and caution for not only existing investors, but potential would-be buyers too.
So, let’s have a look at SCE, what it is about, the potential for its highly rated patented technological products and importantly, what the ultimate rewards could be for shareholders.
The company, which floated in 2004 was originally a tech spin-out of ICI, where it was focused on developing next generation carbon-ceramic products, that ultimately saw it focusing on ground breaking carbon-ceramic brake discs, for both automotive and aerospace markets.
Over the years progress appeared at times to be slow, as is often the case for newcomers looking to make that all-important breakthrough, with R&D investment eating up the cash, which in turn saw the shares remaining largely in the penny basement arena.
One of the major problems with many of those coming to market with what is said to be a unique offering, is that there already exists other players which are very much advanced operationally and these are often dominated in the respective markets by a number of players including major big hitters.
In the case of SCE however, the carbon fibre ceramic automotive brake discs space that it is focused on, sees really only one other serious competitor, that being Italian giant Brembo.
Additionally, there is an extremely high barrier to entry, which for a large part deters would-be newcomers embarking on the route.
As for the product, typically, carbon ceramic brakes are found in the top end of high- performance cars such as Porsche, Ferrari, Lamborghini and Mercedes amongst others.
Although the product is not surprisingly more costly than traditional offerings, there are numerous advantages that are particularly apt and applicable to the higher end market it serves.
These include no corrosion as are found with iron rotors, enabling the keeping of effectiveness and performance over time.
There is also far greater heat management, alongside a lower wear rate which also sees a constant consistency in performance at all operating temperatures.
Other significant advantages include a marked reduction in weight, being typically 50% lighter compared to a cast iron alternative.
Although specifically targeting and operating at a high-end market, looking ahead, opportunities appear to be there across the EV space too, which driven in part by environmental benefits could potentially provide additional significant revenue streams over time.
The environmental aspect is perhaps as yet, an overlooked part of the investment case here, as where as with fixed engine emissions, regulators have more recently turned their attention to brake and tyre dust.
As a result, from January 2025 being the earliest date, strict requirements will then apply for brake and tyre abrasion on all newly registered passenger cars.
Given that CC disks are already proven to half the pad dust, then there is likely to be additional interest and adoption as that date nears and indeed, some of the major players are already embracing the technology for that very reason in advance of the new standard.
In terms of revenues at SCE, anyone taking just a brief look may be inclined to pass it over, as sales went from just £1.3m in 2016 to the £2.3m recorded in 2021, with losses continuing to be recorded.
Whilst the current market cap of £84m at 33.5p per share may well deter fundamental focused investors from proceeding any further, I personally believe it is certainly worth delving deeper here, where serious upside could be closer to hand than at first appears.
Of course, over the last few years we have suffered with the pandemic causing widespread disruption across numerous industries, with automotive certainly not immune from the effects and fall out.
That said, SCE has actually made tangible progress throughout the period which has seen the recent reporting of a substantial increase in its revenues for full year 2022 to £5.1m.
Those numbers followed on from a raft of previously announced positive news on increasing revenue streams following the signing of significant deals with various OEM’s across the sector, with multi-million pound contract numbers being quoted.
Much of the information regarding identity of these customers is veiled in secrecy for reasons of confidentiality imposed upon SCE, thus, the OEM’s are referred to by numbers, with revenue figures attributed to them accordingly.
At the current time following on from the preliminary results, SCE now states an order book that stands at a whopping £290m with an additional £393m in the prospective contract pipeline.
As experience has taught me though, talk of pipelines should be taken with a large pinch of salt, as firm orders are what really matters in the end, although given the rapidly building momentum, the prospects here do look extremely exciting and promising.
The appetite and now rapid acceleration and adoption of its systems hasn’t been an easy ride though as one would expect, where there have been further funding rounds, such as a £15.8m placing and £3m open offer being the most recently announced in September of last year.
Additionally, whilst SCE unveiled further significant contract news over the last eighteen months, so too has it endured scaling up issues alongside the achievement of hitting specific yields.
Such problems can test investors' patience and even question the company’s ability to deliver, so it therefore came as no surprise to see SCE’s shares drop away from previous highs that had been achieved.
Such setbacks are certainly not uncommon however and I recall visiting ink jet printhead pioneer Xaar in Cambridge many years ago when the shares sat at circa 50p which saw it encountering similar issues on scaling up.
To take comfort from that situation, Xaar did achieve its goals and desired yields, the shares eventually some years later trading around the heady £13.00p mark, thus rewarding the patient investor well.
SCE has been extremely open with the issues it has encountered that included foundry problems and the company has to be commended in its results release for going into such detail to both explain and inform investors.
Those issues have now been fully resolved and although there will no doubt be some further bumps in the road on its journey, the current situation suggests to me that there are plenty of reasons to be cheerful.
Significant strides have been taken across a number of fronts, particularly over the last six months or so and as part of that it has also won two new OEM contracts that has swelled that long term order book to the £290m figure.
Broker FinnCap cites, “with production expected to ramp up in the coming weeks, it marks the transition from a loss made in Q1 to the expectation of profitability in Q2 and going forward, and management is now more confident about its FY23 forecasts. The extent to which the company can catch up the expected c£6m of sales by the mid-year, is moot. It will continue to be capacity-constrained in H1, but additional capacity will come on stream in H2, offering potential for additional production. This will depend on their customers’ (and their supply chains’) ability to cope with a reshaped ramp up. The company states that even on the most pessimistic assumption that the H1 sales deficit is lost for the year, it would still have sufficient cash for its working capital and maintain momentum on phase 3.1 of the investment plan.”
In light of the broker comment above, now is perhaps a good time to expand further on the company and its prospects, following my catching up with Chairman David Bundred, who boasts a wealth of industry experience and as I soon learnt, tells it very much as it is.
The Chairman has certainly been around the block a few times with his industry roots going back to Girling Lucas where he was heavily involved in anti-lock brakes.
Although that was a different technology, it was nonetheless in the disruptive mould.
He subsequently became CEO of a brake pads company, so he was extremely familiar with the industry and its workings prior to joining SCE.
That coming on board came about some years back now, where having first been involved in a consultancy role was then invited to step in as Chairman.
As to where the SCE business is now at, Bundred describes it as being on the cusp, where he adds that as it stands with everything humming, they can supply £20m per year although given what they are doing, that will move to £50m in a few months time.
As highlighted at the outset, such a journey as SCE has embarked upon takes magnitudes of time and Bundred speaks of effectively three stages on its commercial journey.
“The first stage is to prove that the technology works and we did that some six years ago, then once that is achieved, you’ve got to prove that customers will buy it and at a price you can make money on it.”
That was done too and the Chairman says it has been achieved in spades as they know absolutely that the product works and customers will buy it, hence his pointing out of a current £300m order book. “The third stage is where we have struggled though”
Bundred adds, with a number of issues frustratingly constraining SCE on a ramping up on volume.
A recent problem he highlights was around ceramic infiltration which proved extremely difficult to solve, but like other aspects encountered he says that these are now all sorted.
He adds that problems always get solved one way or another in the end and that SCE certainly hasn’t been demand constrained, rather it is very much the other way.
One OEM customer whose name would instantly resonate with almost anyone out there, but cannot for confidentiality reasons be named here, has already said that it will take whatever amounts SCE can supply, which surely suggests that the product is every bit as good as claimed.
Competition of course, is always the threat for any emerging business, but as mentioned at the outset there is really only one other player in the market, that being Brembo.
Bundred says that as frustrating as the delay issues have been, it at least explains why there are really only two companies in the market, where the barrier to entry is extremely high.
“There are two others in the world that do carbon ceramics” Bundred adds, “one is in China, the other is Korean, but neither appear credible or have any business and aren’t talking to any of the OEM’s.”
Whilst the Chairman doesn’t discount new entrants such as those or others emerging in what is currently a two billion pound market and rising, he points out the time and complexity they would encounter to achieve their goals.
He says that even if a new product is suddenly unveiled, it then takes at least five years of testing with the automotive players, before even proceeding to the next stage.
Being extremely safety critical means that getting it right and spot on is paramount, hence the lengthy timeline of bringing such products to the market ahead of any adoption.
Given that Brembo is its only real competitor, I am intrigued to know just how SCE’s product stands up against the major dominant player, particularly in light of its having taken one major name contract from it to date.
Bundred believes that Brembo will have to come up with something new or improved and that will present the real competition as opposed to potential new entrants.
The contract win from Brembo was, he informs me, achieved on superior tech grounds, where he says that right now SCE's product effectively kicks Brembo’s into the woods.
Returning to the unwelcome and hindersome issues that have been endured, I was interested to know how that may or may not have impacted on their relationship with SCE’s customers.
Bundred, is happy to expand and tells me that keeping the morale going through the difficult six month period is his job and is something he has always done, adding that he had been in deeper holes before.
“The first thing you have to do is be completely open and honest with your customers, a complete open book. Technology issues happen and always get sorted, although if you miss a beat customers will soon send someone along, miss two or three beats and more turn up, until eventually you end up with a bus load”.
Concluding, Bundred says that such problems are well known across the industry, but in its case once solved, SCE’s real issue was just not having the capacity to service the demand on catch up.
Now however, things appear to be firing well, where he informs me that the speed and take up from the problem solving has actually surprised the team.
With significant revenue numbers lined up, the growth path is clear to see with an extensive runway, where SCE is and will be supplying major industry names.
One OEM that hasn’t appeared to feature for a while is OEM 3, where SCE was going through a specific testing process with it.
Bundred tells me that SCE spent a lot of time and money on the process and successfully passed all of the tests.
During that time and the process however, other extensive business came through for the company resulting in no spare capacity to service that OEM until at least 2025.
Additionally he says that the OEM concerned hasn’t brought out a new model recently and although they haven’t been talking much, there has been some contact and the relationship remains intact.
Although SCE has plenty to be going on with which should deliver significant revenue growth and the all important breakthrough into sustainable profitability, the subject of application to EV’s is also an interesting area for the future.
Industry opinion is divided on this, given the current cost of ceramic discs, implying that it will not be viable. Bundred is open minded but believes that it will happen in due course.
Much of the cost on what they produce at SCE is, he says, down to size, so they have been actively engaged with customers in relation to potentially moving to smaller discs, which would drive down costs.
Although this sounds early stage and as Bundred says they have a plenty big enough market on which to concentrate on for a number of years, he does feel it is something that will emerge.
Looking ahead on the news front the Chairman tells me that there should be a trading update shortly before the forthcoming AGM held in June and one would hope that the news will proceed in a positive vein.
Funding for now, appears adequate, but I suspect that further down the line, once numbers are delivered as expected and the growth curve accelerates, then SCE may wish to further cement its position with some additional funds.
Speaking of the last raise and the price it was executed at, Bundred sounds a note of real frustration as he says the timing unfortunately suddenly clashed with the Truss/Kwarteng September fiscal statement that sent shock waves through the financial markets.
That couldn’t have come at a worse time for SCE’s plans for the raise which was originally set higher than the 40p than what was eventually pitched.
Money and commitment suddenly became tight across the investment community which suggests that the company perhaps did well to get it concluded at what has been perceived as a disappointingly low figure.
Certainly, the last seven or eight months have been difficult and testing for SCE, as has been reflected in the share price performance.
However, with issues now resolved and revenues intact in a massive market open for long term growth then the share price should, in time, duly follow northwards.
Headcount across the company now stands at around two hundred I am told, but given that there is an ongoing recruitment process in place, Bundred expects that number to swell up to close to two hundred and fifty by next year.
Two brokers are covering the stock and one of those FinnCap is forecasting revenues for this year of £16.2m with adjusted EBITDA at £1m and £0.9m pre-tax loss.
That then moves to £30.5m and £8.1m next year which should, according to the broker deliver an adjusted pre-tax profit of £4.7m.
Those numbers don’t look aggressive given what we know and if production continues to proceed positively without further issues, then there must surely be potential for some upside risk.
Still obviously in the speculative mould at present, but with a proven and what appears to be a superior product there to meet demand then the risks should be reduced as the company takes further strides forwards.