Rudi's View | Jun 01 2011
This story features COCHLEAR LIMITED, and other companies. For more info SHARE ANALYSIS: COH
This story was first published two days ago in the form of an email sent to paying members.
By Rudi Filapek-Vandyck, Editor FNArena
It was the year 2005 and investors had started warming to the prospect of a new era of stronger commodity prices. This was reigniting interest in everything related to commodities, from the large and the known to the small, the long forgotten and the exotic. On the other end of the spectrum were biotech stocks of which many had shown lots of promise and excitement, but most had proved disappointing for both investors and for traders.
Combining one with the other, I predicted biotech stocks were about to be ignored and forgotten by traders, journalists and investors alike. Upcoming miners were offering more potential, more tangible prospects and an all-encompassing concept that was yet to conquer the minds of everyone close to the Australian share market: the Commodities Super Cycle.
Though my view at the time was vilified and fiercely rejected via investor blogs and through online chatrooms, it didn't take long before stockbrokers ceased coverage on the sector, former biotech darlings were dropped from major stock indices and both mainstream journalists and investors lost interest overall. One of the leading analysts at the time, Southern Cross Equities' Stuart Roberts, soon stopped publishing his weekly newsletter and proprietary biotech index. He remained at the brokerage but took on a wider, healthcare research role. Just before he did, he dropped me an email: "that was very prescient, Rudi".
The biotech industry in Australia had entered its "nuclear winter".
Apart from a half-baked comeback for Biota's ((BTA)) flu vaccine Relenza, not much seems to have happened in the sector over the past six years. Other than falling share prices, numerous product flops and corporate failures, there has been the occasional foreign takeover and more than one well-intended IPO or capital raising has been cancelled due to an acute lack of investor interest. There has been no major new product development and certainly there has been no corporate follow-up on the success stories from the previous ten years.
Today, Cochlear ((COH)), CSL ((CSL)), ResMed ((RMD)) and to a lesser degree Ansell ((ANN)) are still among investors' favourite choices outside the mining sector, but they are all mature profit generators that originate from a previous era, when 'biotech" and "early healthcare" were considered cool and full of promise, instead of synonymous to "eternal promise" and "money eaters". Yet, what doesn't kill us makes us stronger and the principle also applies this time.
While under the radar for most investors and market observers, the life sciences sector in Australia (as the old biotechs have now been relabelled) has built a new future. From my angle, this new future looks like a bright and promising one. The new generation of tomorrow's sector leaders not only offers tangible results and revenues (or is very close to), but also strong management, proven business nous and acumen and flexible and adaptable business models. At the same time, investor euphoria from 2005-2007 related to the Commodities Super Cycle has evaporated and investors have come to realise China's hunger for energy and base materials is not an easy and one-way street to super investment profits.
This now, I believe, is creating fertile ground for a "return of the living dead". Life sciences companies are able to generate sales and profits and this next generation will increasingly put investor scepticism and journalist scrutiny successfully to the test in the months and years ahead. But don't just take my word for it. One of the leaders in this new breed of high-tech companies, Mesoblast ((MSB)) recently made its way into the ASX200 index. The above mentioned Stuart Roberts last week returned with a day-long Life Sciences conference in Sydney. Above all, share prices for many of these new leaders have outperformed the broader market, including small and large cap resources, over the months past.
While an unexpected European rejection caused a mini-crash in the share price of Pharmaxis ((PXS)) in May, highlighting this sector does not come without risks, overall confidence inside the sector hasn't been this high for many, many years. I believe that in five years from now daily interest from media, investors and market experts will be exponentially higher, and there will be more talk about the "new Cochlear" than any of us can bear. If we look back in 2016, we will conclude that 2010-2011 provided us with the early signals of a sector-wide turnaround.
Take it from the guy who years ago predicted biotechs were out and miners were in: it's time to start paying attention again. Those corpses, left for dead in the shadow of the Big Commodities Revival, are coming to life and their legs will become stronger and stronger over the next few years. To assist readers in their early catch-up research on the sector, I have lined up my five personal favourites below.
Cochlear ((COH)) – A Special Mentioning
If the Greek had created a God for medical devices his name would have been Chris Roberts. All jokes aside, first at ResMed ((RMD)), and the past years at Cochlear, Roberts has set the ultimate benchmark for everyone else in Australia's life sciences industry, and the bar is very, very high. Cochlear is innovator, international sector leader and the model to which everyone else aspires. All this might come as a surprise to anyone who has been reading my writings on Cochlear shares over the past two years, but I never doubted the quality of either Roberts, Cochlear or any of the company's world leading products.
My problem with Cochear is that management is doing such an excellent job that investors simply see no other choice than to chase the stock all the way to Price-Earnings multiples in the mid-twenties. That's when, in my view, alarm bells should start ringing. When a stock is trading on a PE multiple of 26 the overall risk profile automatically increases exponentially. Cochlear shares have on balance gone nowhere since December, which might seem like a good achievement given the share market itself is weaker, but I think Cochlear shares wouldn't have performed much differently under different circumstances.
I believe Cochlear has become the best of the best of what Australia has to offer in technology and medical devices, but I also remain of the view that management's success is setting up new shareholders for major disappointment. Believe it or not, but Cochlear is a solid and steady dividend payer, it's just that because of the elevated PE multiples, investors seldom have the chance to pick up a decent yield from the shares. Should Cochlear be on investors' radar? Absolutely. Should investors consider buying at current lofty prices? Negative. Unless you want to throw my warning in the wind.
Cochlear shares traded at $75 in May 2010. They closed at $78.65 on Monday. See my point? (They've been as high as $84 recently).
QRXPharma has the potential to emulate the success of CSL, Cochlear and ResMed in the years ahead. This is not just my personal opinion. Just ask around inside and around the industry today. Everyone talks "quality" and "strong management". The company is effectively an old dog which has developed a few new tricks. Built upon the combination of two existing pain killers, management is now en route to convincing regulators and investors worldwide that two painkillers combined are much better than what is being used in hospitals and sold via pharmacies around the world today. And clinical trials have been backing up the claim.
Admittedly, the fact that QRX is combining two existing, already approved productsshould make life much easier in terms of achieving regulatory approval. Management displayed flexibility in developing the company and its main product line. Soon QRX's MoxDuo will be put under scrutiny by the FDA in the US in the form of a New Drug Application. All the preceding signals have been positive and those stockbrokers who cover the stock have become quite excited. Note the company's board is chaired by Peter Farrell, otherwise known as the founder of ResMed.
In share price terms, QRX shares have significantly outperformed the share market since December, with the share price more than doubling while others were struggling. While the (blue) sky remains the limit, it would appear the shares have now run into temporary headwinds after peaking above $2.40 only days ago. As such, QRX seems to have already followed in the footsteps of Cochlear with temporarily too expensively priced shares. Subscribers to FNArena will instantly know what I am talking about when I say that QRX has provided another example of the Icarus Syndrome.
No doubt, everything will be forgotten by the time FDA approval will be received. Mid 2012?
Is it a biotech? Or is it a new developer of consumer beauty products? Management at Phosphagenics will be hearing the question a lot in the months and years ahead. This is a platform company, which in essence means the company has created and developed a technology that lends itself to the development of a multitude of applications and other technologies. The company's core technology allows delivery through the human skin (without irritation or damage) which opens up alternatives for pills, injections and even medical operations. Last year, the company decided to use its core technology for consumer products and the result has been new anti-ageing products in high-end consumer channels in the US, and the best selling new brand at Myer's. (Check it out at www.elixia.com.au)
The world of "skincare" is currently dominated by the likes of L'Oreal and consists predominantly of expensive creams, rubs, gels and sprays with a little scientific flavour, sustained by millions of dollars in marketing and promotion. Phosphagenics' products are making a difference in that they actually do have the scientific credence and, apparently, the (better) results attached to it. Already, commercial revenues thus far have exceeded everyone's expectations, including the US partner's, and new products are in the pipeline or about to be launched. Acne for teenagers should be a no brainer, as is an anti-cellulite cream. Soon the company will move into US hair care products.
In the background of early promise and successes in the consumer markets, Phosphagenics continues to develop new products and applications for its initial target market, therapeutic drugs and treatments. Major partner 3M is enthusiastic about trialling and developing the world's first patches for analgesic drug oxycodone, but that's just the tip of the iceberg of what tomorrow can possibly deliver. Despite incoming revenues from cosmetics, Phosphagenics is still burning cash on the medical side of the business. Further capital raisings cannot be excluded at this stage.
Anteo Diagnostics ((ADO))
In very simple terms, Anteo Diagnostics has developed a chemical glue that improves pathology tests in about every manner possible. It makes them easier to assemble and more effective in their end results. Similar to Phosphagenics, Anteo's management is already looking beyond the medical sector for wider usages of its "surface coating", called Mix&Go. We all might be surprised by what type of consumer products could benefit from a little extra, microscopic glue. For company management, nothing seems too far fetched. It is publicly contemplating options such as bank notes with a tiny microchip attached (so tracing and identification becomes much easier). Science-fiction from a Brisbane lab? You bet!
In the short term, all eyes will be on further licenses for Mix&Go in the pathology sector. Anteo has already licensed Bang Laboratories in the US and Merck KGaG in Germany, but is ultra-confident others will follow in due course (exact timing remains uncertain). More such deals significantly reduce the odds of further capital raisings. Management is confident.
Meanwhile, the share price characterises all the hallmarks of a micro-cap stock, trading between $0.05 and $0.10 since early 2010. If management can deliver on the current promise, this stock will re-rate and start trading on actual revenues and profit metrics. When and whether that will happen is related to deals, deal, deals. As said, management is confident. All that needs to follow is… deals!
Carbohydrate-based drugs are the new black in modern medicine, according to some market experts. If true, that would be good news for Alchemia, considered one of global leaders in the field. The company is awaiting FDA approval for its lead product, blood thinning drug fondaparinux. It goes without saying, from the moment the news of approval hits PC screens across the globe, Alchemia's share price will rally. However, investors be warned, analysts at RBS Morgans predict this will trigger profit taking by others, potentially turning the immediate post-FDA response into a tricky and volatile one.
Further in the pipeline are cancer drugs and HyACT, a technology device to deliver drugs into tumours. Post FDA-fondaparinux, the next focus will be on Phase III trials for HA-Irinotecan, a cancer drug. CEO Pete Smith is an experienced old hand in the industry with a solid reputation and quality tag attached. Alchemia shares have spent most of their time in between $0.60 and $0.80 since late 2009 (it has to be said: they also revisited $0.40 at some point in 2010). Target prices and earnings projections amongst analysts covering the stock vary a lot, similar as to all others mentioned (even including Cochlear).
Bottom line: if FDA approval follows and Indian partner Dr Reddy's Laboratories manages to successfully penetrate what is believed a large and growing market currently dominated by GlaxoSmithKline (US$274m per annum sales in the US), today's share price will prove exceptionally cheap on (let's say) FY13 earnings. That too goes for all of the above (not so much for Cochlear).
The list wouldn't be complete without the mentioning of adult stem cell specialist Mesoblast which recently became a member of the ASX200. Mesoblast received a big boost in market credibility when US company Cephalon decided to buy a 19.9% equity stake in addition to signing off on a deal that can potentially lead it to paying some $1.7bn to its Australian partner in the coming years. Cephalon is about to be swallowed up by Teva Pharmaceutical, but management at Mesoblast appears confident the end outcome will be an even better one for Mesoblast and its shareholders.
Mesoblast's stem cells will initially be used to reduce the occurrence of heart failures post heart attacks. Further down the track lie bone marrow transplant applications. Alas, despite the ASX200 membership and a market capitalisation of more than $1.6bn, the shares are still awaiting coverage from any of the leading stockbrokerages in the market. This too is evidence the re-invigorated life sciences sector still has a long way to catch up.
Subscribers of FNArena can find more information about all companies mentioned on the website, either via Stock Analysis or via news stories. Companies are mentioned in no particular order and for further research purposes only.
(This story was written on Monday 30th May, 2011. It was published in the form of an email to paying subscribers on that same day).
For Your Calendar:
– 2011 AIA National Investors Conference
Date = 1st September (The Conference runs from 1-3 September)
Place of action = Sofitel Sydney Wentworth Hotel, 61-101 Phillip Street, Sydney
Theme = Market beating dividend stocks
– There's an early bird discount rate for this event, see http://www.investors.asn.au/events/national-conference/
– Detailed conference program information can be viewed here http://www.investors.asn.au/events/national-conference/program/#program
– Information regarding the speakers can be viewed here http://www.investors.asn.au/events/national-conference/speakers/
– Your Editor Presenting in Hobart and Sydney in June
Following on from two very successful "Rudi unplugged" presentations in Melbourne, FNArena editor Rudi Filapek-Vandyck will be presenting in Hobart and in Sydney in June. Presentations in Hobart take place on Friday and Saturday 24 and 25 June at the Mercure Hotel, 156 Bathurst Street (more details below). The presentation in Sydney will take place on Thursday June 16 at the offices of BoardroomRadio where the event will be recorded.
Each session will last 2 hours and will take place in front of small audiences to allow for questions and easy interaction. Tickets are $25pp.
This is a unique opportunity to meet the founder of FNArena and the architect of unique tools and services that assist investors across Australia in their daily market analysis.
Similar tothe "Unplugged" sessions in Melbourne, Rudi will provide and explain his views on financial markets and investing (no financial advice, but a lot of common sense), plus he will explain the ins and outs of tools and services he designed at FNArena. Audiences can freely interact and attendees are encouraged to ask questions, such as: Does David Jones always beat Rio Tinto? Why should investors pay attention to dividends when there's a once in a life time Commodities Super Cycle? Are we at the advent of a new bull market, or is it the opposite?
There is no set format, so all events will have their own atmosphere and character.
The Melbourne presentations in March received a lot of praise from attendees. Here are a few messages received as feedback:
"I greatly enjoyed your informal style of investment briefing, and found it very informative. I attended your session with an open mind and was pleasantly surprised at the quantity and quality of your delivered content. May I suggest that having a small size audience gives a lot more personal touch."
"I really enjoyed the session on Saturday. The small group format makes the session more beneficial as everyone has more than one or two opportunities to ask questions. I certainly got a lot out of it. New thoughts but also reinforcing and reminding me of investment rules and themes that I already had considered."
"Enjoyed the Melbourne session very much. Intimate but intelligent audience asking sensible questions. Like the informal ambience and appreciate very much your Editor’s observation of how the share market operates. I concur with Rudi that individuals should invest differently from the Funds."
Limited seats available for each session. To purchase your ticket, choose your preferred event and click on the link to process your payment online. Alternatively, send an email to email@example.com
BoardRoomRadio, Suite 2, 50 Stanley Street, East Sydney
Thursday, 16 June 2011, 7-9pm
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Mercure Hotel Hobart, 156 Bathurst Street
Friday, 24 June 2011, 7-9pm
Saturday, 25 June 2011, 10am-midday
To purchase a ticket for Friday (7-9pm): http://www.fnarena.com/index2.cfm?type=dsp_cart&pid=32
To purchase a ticket for Saturday (10am-12): http://www.fnarena.com/index2.cfm?type=dsp_cart&pid=33
For more info SHARE ANALYSIS: ACL - AUSTRALIAN CLINICAL LABS LIMITED
For more info SHARE ANALYSIS: ADO - ANTEOTECH LIMITED
For more info SHARE ANALYSIS: ANN - ANSELL LIMITED
For more info SHARE ANALYSIS: COH - COCHLEAR LIMITED
For more info SHARE ANALYSIS: CSL - CSL LIMITED
For more info SHARE ANALYSIS: MSB - MESOBLAST LIMITED
For more info SHARE ANALYSIS: PXS - PHARMAXIS LIMITED
For more info SHARE ANALYSIS: RMD - RESMED INC