Small-cap momentum stocks: Quixant and Warpaint London

To wrap up my review of stocks from my recent momentum screen, this week I’m going to look at two small-caps from the screen results.

Both of these firms have recently issued bullish trading updates. I think they both have the capacity to deliver substantial growth over the next few years, if things go to plan.

(As a quick recap, I’ve also covered three FTSE 100 stocks from the screen and two mid-caps here.)

Quixant (LON:QXT)

AIM gaming technology stock Quixant (LON:QXT) has traded on the London market for nearly a decade, during which period its shares five-bagged … and then came crashing down again:

The 2018-20 share price slump was caused by a pre-pandemic slowdown in customer orders. This was then compounded by the impact of Covid-19, which caused a near-total shutdown in Quixant’s core casino market.

However, the company appears to have moved on from these setbacks, aided by a very strong recovery in the US casino industry. As I’ll explain, I think Quixant is now starting to look like an attractive growth play again, with good earnings momentum and a reasonable valuation.

About Quixant: the group was founded in 2005 to produce computer systems for casino gaming machines. Co-founder Nicholas Jarmany remains on the board as deputy chairman and is still the company’s largest shareholder, with a 17% holding.

Today, the business is divided into two divisions:

Quixant: the core business generates about 70% of profit, producing computer systems for casino-type gaming and sports-betting machines. The firm has also recently expanded into cabinet design and recently reported a $4m order for this new line:

Images © Quixant

Densitron: this division specialises in “human-machine interface” technology. Its main customer base is the broadcast industry, with products such as touchscreens and control devices:

Image © Densitron

Quixant acquired Densitron in 2016. Two of Quixant’s founders worked for Densitron before founding Quixant, so we might speculate about the level of objectivity in that transaction. However, we can at least be sure that they knew the business well.

Recent trading: the group’s October trading update reported strong trading in both the Quixant and Densitron businesses. Full-year guidance for adjusted pre-tax profit was increased from $8.8m to “no less than $10m” – the second such upgrade this year.

Customer demand is said to be “buoyant” , while supply chain problems are easing. Previous price increases are supporting a recovery in gross margins. Management is confident of continued progress in 2023, despite the background risk of a recession.

This recent interview with Quixant’s CTO provides some good background and suggests to me that the Las Vegas casino industry is booming. Demand for new and existing products sounds very strong.

Quality: Quixant has historically generated double-digit operating margins and ROCE. I think the potential opportunity here for investors is that the firm will be able to rebuild this profitability as growth continues and economic conditions stabilise:

At present, group overheads appear to be eating into underlying profitability significantly:

• Quixant segment margin: 21%
• Densitron segment margin: 12%
• Group operating margin: 6%

If the company can continue to grow while keeping central costs under control, then I think we could see decent operating leverage, with profit growth outpacing sales growth.

Fundamental quality seems strong, too. Although the company used much of its cash flow to build inventory during the first half, the long-term record of net cash and unchanging share count suggest to me that this has been a prudently managed and cash-generative business.

Valuation: I don’t think the Quixant shares look especially expensive at current levels, given the apparently strong outlook for growth.

However, if growth disappoints then the stock could suffer another correction. Quixant’s trailing 12-month multiples do not look cheap to me:

Momentum: Quixant’s strong momentum score is what attracted my initial attention. The stock scores highly on all counts.

Earnings estimates: the company has upgraded its full-year guidance twice this year. Analysts covering the stock seem confident that this rate of improvement will be maintained in 2023 as well:

Price momentum: Quixant’s shares have doubled from their 2020 lows and have risen by 7% over the last 12 months:

In a troubled market for small caps and AIM, that’s been enough to leave the stock ahead of the pack, with positive relative strength scores:

Summary: I think there’s an element of cyclicality to this business, in that Quixant is dependent on spending and expansion cycles among casinos and their tier one suppliers. A slowdown in such spending appears to have caused problems in 2019.

A decent recovery now appears to be underway. Quixant’s Densitron business also appears to offer opportunities for diversification, and perhaps a greater proportion of sales direct to end users.

Although this stock isn’t without risk, Quixant has a cash-rich balance sheet, two founder directors on the board and a history of profitable trading. Against this backdrop, the company’s growth guidance seems credible to me. I think Quixant could be worth considering as a momentum play at current levels.

Warpaint London (LON:W7L)

Paul covered the latest results from Warpaint London (LON:W7L) in an SCVR in September and was impressed by recent progress at this make-up company. However, the shares have risen by 50% since then, reducing the value on offer:

I’ve kept an eye on this founder-led business since its arrival on AIM in 2016, and have been encouraged by the return to growth seen since the pandemic. Notable progress includes strong international growth – overseas revenues now exceed UK sales.

Do the company’s strong momentum and improving outlook still leave room for further upside for new investors?

Recent trading: Paul’s excellent analysis from September is worth reading for a more detailed understanding of recent trading.

In short, group sales rose by 37% to £25m during the first half of the year, with international sales up 55% to £14.8m.

Adjusted operating profit bounced back to £4.8m (H1 2021: £1.6m) as operating leverage boosted margins and lifted TTM profits back to historic highs:

Quality/fundamental health: Warpaint London traded through the pandemic without issuing any new shares and has minimal debt. Historically, cash generation appears to have been quite strong, supporting an attractive dividend:

More broadly, Warpaint’s Piotriski F-Score of 7/9 suggests a positive picture of improving profitability and cash generation:

I think the foundations are in place for continued growth. Equally, if there’s another slowdown, I’m fairly confident the business should be able to survive without suffering financial distress.

Momentum: Warpaint London’s MomentumRank of 98 is very strong, and this is reflected in both earnings and price momentum. However, I think there are a couple of points worth noting.

Earnings estimates: The broker trend chart shows that earnings forecasts have been upgraded three times over the last year – excellent.

However, expectations for growth over the coming year appear to have weakened slightly (the gap between the two lines):

In September, CEO Sam Bazini said he expected to issue a further trading update later in the year. So far there’s no sign of this, but it would be interesting to have an update before Christmas.

Price momentum: the stock’s technical momentum looks very strong indeed:

However, the StockReport graphic show that the shares are starting to look quite fully valued relative to its sector and to the wider market:

While the dividend yield remains attractive, sub-10% earnings growth and a P/E of 20 do not scream value to me. The rolling PEG ratio of 2.2 reflects this.

Summary: Warpaint London appears to have surmounted the problems it suffered soon after listing and has now returned to profitable growth. I’m bullish on the general prospects for the business and I think the shares could still offer value on a medium-term view.

However, in the short term, I’d argue that the share price is probably up with events. At risk of missing out, my inclination would be to wait for the next market dip before buying Warpaint shares.