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Here are two UK small-cap stocks I’d buy right now

James J. McCombie
·3-min read
The UK national flag in front of Canary Wharf skyscrapers where professionals trade shares for a living.
The UK national flag in front of Canary Wharf skyscrapers where professionals trade shares for a living.

If you are looking for UK small-cap shares to buy, I think Surface Transforms (LSE:SCE) and Shield Therapeutics (LSE:STX) look like good picks for a portfolio. I think both have the potential to deliver the kind of returns small-cap stocks are known for, but they also look less risky now due to significant and recent business developments.

A breakout UK small-cap stock

Surface Transforms makes carbon-ceramic brakes. Its proprietary method produces brake discs that are more durable and conduct heat better than its competitors. Surface’s main competitor owns almost all of the market, but the owners of BMW own most of it. Surface presents a compelling alternative for carmakers concerned about this BMW connection.

After many years of trying to crack the market, orders are starting to grow. Surface won several new contracts in 2020. One of them – to be a sole supplier to a global customer – is a huge deal. To be a sole supplier, the customer must have complete confidence in the product and its delivery. Others will take note, and this could be the key that unlocks a chunk of market share in the future.

These new orders should push the company into profitability by 2021, and profits should continue to grow in 2022 and onwards. And I think there is more to come. The carbon-ceramic brakes market is worth around £200m and is growing. A 10% market share equates to revenues of over £20m per year – a significant improvement on the £1m in revenue reported in 2019. I think a 10% market share is achievable. So if you are looking to buy shares in a UK small-cap company, I think you should consider Surface.

Stock therapy

Shield Therapeutics is a pharmaceutical company. Its lead product, Feraccru/Accrufer, treats iron deficiency anaemia. Regulators have approved Feraccru/Accrufer and it is now commercially available. Getting past the approval stage and onto marketing and selling a drug is a significant milestone and reduces the risk of failure. Now the company needs to focus on increasing sales volume.

Shield finds marketing and distribution partners for the markets it wants to enter. The partners pay upfront and milestone payments and royalties on sales. Shield’s European partner sold more of the product in the first half of 2020 than in the whole of 2019. A deal with a distributor covering China, Hong Kong, Macau and Taiwan has been agreed this year and sales could commence as early as 2023.

Finding a US partner would be a game-changer for Shield, and could happen before 2020 is out. The deal with the Asian distributor is worth around £35m in upfront and milestone payments, and 10%–15% of net sales for at least 10 years. I would expect the US deal to be more lucrative. Combining European, Asian and US upfront payments and royalties on sales is expected to tip Shield into positive cash flow and consistent profitability from 2022 onwards.

Owning shares in Shield looks a lot less risky now. Getting to the point of actually making sales of a drug is a huge milestone. The next step is to scale up in existing markets and break into new ones. I think Shield is a UK small-cap stock to buy right now.

The post Here are two UK small-cap stocks I’d buy right now appeared first on The Motley Fool UK.

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James J. McCombie owns shares of Surface Transforms. 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.

Motley Fool UK 2020