Penny stocks are a very special type of company. They have a market capitalization of less than £100m and a share price of less than £1. This means it’s small, but has a lot of potential to jump in value if the business starts to take off. Or they could be companies that were once large but have lost popularity. Here’s one I noticed that I think looks undervalued.

Subject to transformation

I’m talking about him Raspberry bunch (LSE:MUL). It is a British luxury brand known for designing and selling high-end leather goods, especially handbags. It places great emphasis on its ‘Made in England’ heritage and was a much bigger brand a decade ago.

However, over the past year, the stock has risen by 13%, currently sitting at 95p. Although the company is still making losses, the rise in the stock price reflects growing optimism about the turnaround in the business. In the first half results last November, losses narrowed significantly to £6.9m from £15.7m, while gross margins improved to around 69%.

This is due to avoiding cuts and tightening control over costs. Operating costs were reduced by 16%, and management worked to close underperforming stores and streamline the business. In a classic turnaround, the company has become smaller, a situation I like to see that usually leads to greater profitability in the future.

There is also a strategic reset underway. Management is refocusing on Mulberry’s core strength, which I agree is its British heritage. It is withdrawing from weaker international markets and focusing on driving growth in key regions such as the UK, Europe and the US. In fact, some channels have already returned to growth, even as the broader luxury market remains weak. Just last week, it announced a return to the much-hyped ready-to-wear business, under headline-grabbing designer Christopher Kane.

Undervalued looking forward

With a market capitalization of £68m, the stock trades at well below 1x annualized sales, which I use as a fair benchmark. The price-to-sales ratio is only 0.58. For comparison, barbaric By 1.58. This highlights to me that the stock could be undervalued.

If the company can simply return to modest profitability, the earnings rebound could be significant, and the rating could expand quickly. In other words, the stock price is still affected by a lot of bad news.

But when I look ahead, I actually see a lot of reasons why the company could do well. Firstly, cost savings (targeted efficiencies of around £5.9m per annum) should directly boost margins. Second, even stabilizing demand for luxury goods could help, given how weak it has been recently. Third, the brand still carries an intangible value that is not fully reflected in the current stock price. It’s a classic British brand that I think still resonates with a lot of people.

Of course, there are risks involved. The biggest problem I see is that the company continues to be loss making, with negative profit margins and declining revenues. This ultimately cannot continue if the company is to survive (and thrive). Its stake is not very liquid as the vast majority of it is owned by controlling shareholder Challice and the Frasers Group. But even with this concern, I think it looks like a good value and something investors could consider.