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.

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Since it joined the London market in December, HeiQ’s share price has already risen by 70%.

What does it do?

HeiQ appears to have timed its entrance well. The firm’s specialty is treating textiles to make them more functional. This can mean adding an antiviral treatment or making fabrics breathable, water repellent, and odour-free. The company even promises to provide “air purifying” sofas and curtains.

Existing customers mostly seem to be in the clothing sector — names such as Sloggi, Speedo, Patagonia, The North Face, and New Balance were mentioned in a recent presentation.

However, I don’t think it’s too hard to imagine much broader demand in the future for products such as HeiQ Viroblock, which is said to be a “world leading” antimicrobial technology. For example, HeiQ already offers antiviral treatment for aircraft interiors, but I could see this extending to other forms of public transport and the hospitality sector.

Does it make money?

A good story is always exciting, but I don’t buy shares in loss-making start-ups. The risks are too high for my style of investing. Luckily, HeiQ has been in business for 15 years and is already profitable.

According to figures provided by the company when it joined the stock market, annual sales rose from $21m in 2017 to $28m in 2019. 2020 saw a massive surge in growth, with half-year sales of $30m.

HeiQ’s operating profit rose to almost $11m during the first half of last year. This suggests an operating profit margin of more than 30% — an impressive figure.

I’m not sure if this level of profitability can be maintained or if this includes one-off gains relating to the pandemic — for example, PPE sales. However, even if we assume that profits flatten out this year, the stock’s valuation doesn’t seem outrageous to me. I estimate that HeiQ’s share price of 210p might value the stock on about 17 times earnings. I don’t think that’s excessive for a profitable growth stock.

HeiQ shares: my verdict

HeiQ is still below the radar for most private investors. But if the firm can deliver on its potential and maintain recent growth, I think we could be hearing a lot more about this business.

Don’t get me wrong — buying HeiQ shares isn’t without risk. Growth stocks like this don’t always deliver as hoped. I also feel that a lot of growth is already priced into the stock. For these reasons, I wouldn’t put more than a small percentage of my portfolio into this stock.

However, despite my concerns I can see serious growth potential here if things go well. If I was buying a small growth stock today, HeiQ would be on my short list for further research.

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