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Is this penny stock a buy after a 50% plunge this year?

Stacks of coins

A penny stock I’ve been researching lately is Heiq (LSE: HEIQ). It’s a developer of material technology that adds functionality, hygiene properties and other enhancements to a wide range of textiles. The company says it has developed over 200 technologies, many in partnership with major brands, and has seven manufacturing sites around the world.

Heiq listed on the London Stock Exchange by way of a reverse takeover in December 2020 and raised over £60m. The share price began trading at close to 120p and rallied to a high of almost 250p by January. However, the share price has fallen to 89.5p as I write, meaning it’s now in penny stock territory.

So, has this over 50% plunge this year made Heiq stock a buy for me? Let’s take a look.

The bull case

The first thing that attracted me to this penny stock is its history of innovation. For a start, the company has 10 patent families and 180 trademarks that protects its intellectual property. This would make it more difficult for a competitor to take market share from Heiq.

The company showed its ability to innovate during the pandemic by developing Heiq Viroblock. It’s an antiviral and antibacterial agent that can be added to fabric during the final stage of manufacturing. In doing so, it protects the fabric against viruses and bacteria, including Covid-19. The technology has a patent pending, and helped revenue grow by an impressive 80% in 2020.

The markets that Heiq operate in are also large. The company says it’s a global leader in the $24bn textile chemicals market, and the $10bn antimicrobial fabrics market. The development of Heiq Viroblock also widens the company’s addressable market. This should mean there are plenty of growth opportunities available to Heiq, in my view.

The bear case

In the most recent interim results for the six months to 30 June, revenue actually declined by 14% over the same period in 2020. What’s more, adjusted EBITDA (earnings before interest, tax, depreciation and amortisation) fell to $4.8m, from a prior $12m. The company said the decline was due to an exceptionally strong period during the pandemic in 2020.

However, the gross margin declined from 57% to 50% due to supply chain disruptions and raw materials cost inflation. Operating costs also rose 48% as the company continued to invest for its future growth.

This isn’t a good combination of declining sales and gross margin, plus rising operating costs. Heiq also said the rest of 2021 will be unpredictable due to the supply chain issues and cost inflation pressures.

The valuation seems too high to me, taking into account these risks today. The forward price-to-earnings ratio is 29, which is steep when pre-tax profit is forecast to decline by 32%.

Is this penny stock a buy?

On balance, I don’t view the risk/reward for my portfolio as favourable today. The valuation is high when sales and the gross margin are declining. And Heiq says things will stay unpredictable.

So, for now, it’s staying on my watchlist as I view the potential for growth here as exciting. There are better stocks for me to buy right now, though.

The post Is this penny stock a buy after a 50% plunge this year? appeared first on The Motley Fool UK.

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Dan Appleby has no position in any of the shares mentioned. 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.