PSB Monthly Issue December 2008

| December 2, 2008

December 2008


Is your heart important to you?  Your heart’s important to pharmaceutical companies. Cardiac safety is the number one issue all drug companies face today.  Drugs in development as well as those already on the market are under intense scrutiny.

The concern is heart attack and stroke.

Believe it or not, cardiac safety’s the number one reason a drug will be denied FDA approval.  Over the last decade it’s also been the primary reason drugs have been withdrawn from the market.

Just think of the expense.

Pharmaceutical companies spend millions developing drugs, testing and marketing them.

These costs can’t be recouped if a drug is removed from the market.  We’re not even counting the millions (and sometimes billions) of lost revenue.

Vioxx’s a perfect example.

Merck’s blockbuster drug was withdrawn from the market because of cardiac safety.  A number of patients taking Vioxx were dying from heart attacks.

A study later showed patients taking Vioxx were twice as likely to suffer a stroke or heart attack.

The year prior to its withdrawal, Vioxx generated $2.5 billion dollars in revenue. Pulling the drug was costly for Merck.

Their shareholders lost billions when the stock dropped 40% on the news.

Due to the risk of heart damage from unsafe drugs, the FDA took action.  They issued a guidance document called ICH-E14.

It recommends testing all new drugs during the clinical trial process to assess their impact on cardiac safety.

The formal name for the test is “Thorough QT/QTc Study” (TQT).

All you really need to know is TQT looks for heartbeat irregularities with ECG tests.  It’s these irregularities that cause heart attack or stroke.

TQT studies are now an essential part of every new drug’s clinical trial.
If a drug application doesn’t include a TQT study, the FDA often delays or withholds marketing approval.

ICH E14 has spawned a new industry.

Hundreds of companies are offering to assist with TQT studies.  Most of these provide niche solutions addressing a small part of the process.

Only one company offers a complete package.  They’re conducting TQT studies from start to finish.


This amazing company is eResearch Technology (NASDAQ: ERES).
ERES is a market leader in providing Cardiac Safety Services to the drug and medical device industries.

So exactly what does ERES do?

They offer proprietary software and internet based technologies to conduct TQT studies.

They also provide centralized ECG data collection and expert ECG interpretation.

eResearch collects ECG data from cardiac tests and stores them in a digital format. Data can then be shared anywhere around the globe.

The company’s expert cardiologists review and assess ECG data for pharmaceutical companies.  ERES can also submit evaluation data to the FDA for regulatory review.

ERES’s technology and services improve the accuracy, timeliness, and efficiency of clinical trials.  The company is truly a one-stop shop for cardiac safety services.

But here’s the important part.  All of their services are designed to comply with FDA guidance.

More than 275 drug companies use ERES’s services right now.  These clients include 41 of the top 50 pharmaceutical firms worldwide.


Top line growth is impressive.

Revenues are growing at more than three times the industry average.  For the first nine months of 2008, revenues were $103 million compared to $69.8 million in the year ago period.

An increase of 47%.

The company continues to put new business on the books at a fast pace.

Bookings of $142 million over the first nine months of this year already exceed the $138 million booked in all of 2007.  This is revenue the company can count on for 2009.

Revenue growth is strong, but earnings are on fire.

Earnings this year have increased 91% when compared to last year.

Profitability continues to be strong.  Management recently raised earnings guidance for 2008 to $0.50 per share.

These growth trends are nothing new.

Over the last five years, eResearch’s revenues and earnings have each grown steadily at about 20% per year.

For 2009, I expect revenues and earnings to increase more than 20%.
ERES also has an iron clad balance sheet.

The company’s sitting on a cash hoard of $62.5 million with virtually no debt.

Cash flows are growing at an amazing 40% per year.  ERES is well positioned to fund its growth organically and weather any economic downturn.


One key risk is eResearch’s reliance on a few large clients.  If ERES were to lose any of these clients its revenue and earnings would suffer.

A downturn in the clinical trial market is another potential risk.  A decline in drug development could reduce the need for the company’s services.

Another risk is increased governmental regulation of the clinical trial process.  A significant change in regulations could require costly product modifications.


ERES shares are exactly what we’re looking for – a misvalued stock with great growth potential.

Revenue and earnings growth blow away the industry averages.

Over the last 12 months, revenues are up almost 48% and earnings are up more than 90%.  The industry averages are just 17% and 9% respectively.

eResearch sports a price to earnings ratio (P/E)of 12.

That’s significantly under the industry average of 17x.

Given the company’s higher revenue and earnings growth rate, the stock deserves a higher multiple.

With earnings expected to grow by 28% in 2009, a P/E of 25x would be more reasonable.

Using eRT’s 2009 earnings estimate of $0.65/share and a P/E of 25x, a fair valuation of ERES shares is $16.25.

That’s 188% higher than its current price.

But that’s not all…

Management is providing extremely effective leadership.  Return on invested capital is twice the industry average at more than 20% per year.

By this measure, ERES earns twice as much as its competitors from each dollar invested into the company.

Institutional investors own 77% of all outstanding shares.  Over the last six months, one institutional investor purchased almost 1 million more shares.

Insiders also own a substantial 21% of shares.  This ensures management’s interests are aligned with shareholders.


eRESEARCH TECHNOLOGY (ERES) is trading at $5.64, BUY up to $7.00.

Use a stop loss of $2.80 on this position.

Don’t forget your position sizing and stop-loss rules.



It was just a few days ago I sat down to a huge Thanksgiving meal.  Unfortunately, I wasn’t in a great mood.  My Detroit Lions were just embarrassed on national TV losing big time (I guess there’s always next year).

I was quickly shaken from my sour attitude by the smell of something heavenly.

It was the big roast turkey.

The spread was amazing, mounds of honey glazed ham.  Double mashed potatoes, dressing, cranberries, green peas, sweet potatoes.  The parade of food being passed down the table just didn’t seem to end.

Then desert followed.

More pies than I could count.  I remember two in particular, the apple and the pumpkin.

As you’re finishing off the leftover turkey this year, let me give you something to ponder.

There’s a huge new trend in America.

It’s a trend towards healthier eating… and it’s been picking up momentum for several years.

To be honest, I lost count of the number of people who tossed their diets out the window on Thanksgiving.

So let me ask you this… where do you get your healthy food?

Unless you’re one of the very few who grow your own, the average American buys their food from a grocery store.

So where does the grocery store get their food from?  Seriously…

Think about it for a moment.

Right now, there are hundreds of small businesses focused on producing food.  The very same food that’s sold in the grocery store.  Most of the major food brands these days buy ingredients from smaller suppliers.

And the grocery stores themselves often buy private label products to sell under their banner.

It’s a huge industry many people never even know about.


I discovered a penny stock thriving in this industry.  The company is called SunOpta (STKL).

Now, let me point out an important fact.

SunOpta isn’t some tiny run of the mill company.  Their business does more than a billion dollars a year in revenue.

As a matter of fact, the company’s reported more than 44 consecutive quarters of revenue growth.  In a bit I’ll tell you just how misvalued SunOpta is (and why it’s such a huge opportunity!)

But first let me tell you a little bit about their specialty.

SunOpta is focused on the fastest growing food segment in the industry.

The health food and organic market.

These natural food products are estimated to account for $56 billion in sales.

Today, more than ever, people understand the connection between good food and good health.  Organic food, once hard to find, is now readily available.

Obese children and adults are taught to search out healthy food alternatives.

As such, organic food sales are expected to climb more than 18% per year between 2006 and 2010.  Not bad for a $20+ billion industry.

SunOpta is a huge player in this industry.  They’ve profited from their “Farm to Fork” mentality.

Just look at the Sunopta Grains & Food Group.  The company provides soy farmers with seeds, and agrees to purchase the harvest.

Once the harvest begins, SunOpta process the soy.  They make either processed soy other food manufactures need (like soy meal and soy flour) or they make consumer-oriented products (like soy milk).

Then the end market products are shipped directly to grocery stores.

Not only is the SunOpta “Farm to Fork” model focused on soy, they do it for other grains, berries, and fruits.

But that’s not all…

The company also utilizes an extensive global network to obtain frozen and dried fruits, vegetables, grains, coffee, cocoa, and natural sweeteners.

The global network is quite extensive.

They import and export products from more than 45 countries.

SunOpta has people on the ground providing an inside look at crops and harvests.

Who’s buying SunOpta’s processed food?

Their customer list is amazing:  Kirkland, Kraft, Dannon, Trader Joes, McDonalds, Post, Gerber, Pepperidge Farm, Kellogs, Jamba juice… I could go on and on but I don’t want to bore you.

Other processed and packaged foods for SunOpta are sold at the major grocery stores.  Albertsons, Costco, Safeway, Trader Joes, Target, Whole Foods, and Wild Oats, just to name a few.

The company has two other businesses. One’s focused on silica free abrasives, and the other on alternative energy (ethanol). Neither are big enough to spend any time talking about.

On to more important items…


SunOpta’s had over a decade of high octane sales growth.

For the third quarter of 2008, revenues were $287.7 million.

The company’s seen a 21% increase from all of SunOpta’s businesses this quarter.

We’ll see total revenue surpass $1 billion in 2008. We’re expecting $1.2 billion of revenue in 2009.

Strong and consistent earnings growth is the norm at SunOpta.

Earnings for the third quarter grew 72% to $5.2 million.  So far this year, earnings have hit $13.5 million, an increase of 80%.

Recently the company hit a rough patch.

They lowered 2008 guidance to a range of $0.19 to $0.23 per share. This was necessary because of a slowdown in the abrasives business and unfavorable changes in foreign exchange rates.

Management guidance for 2009 is expected early in the year.

Now, management has a reputation for providing conservative guidance.  Given the gloomy outlook for the economy right now, I wouldn’t be surprised if management sandbags more than usual.

The balance sheet is strong however.

They have $30 million in cash and debt of $204 million.  Its current ratio is 1.8x, and the debt to equity ratio is 0.8x.  This shows debt levels aren’t unreasonable for a company like this.

Here’s the part you should be really interested in.  SunOpta’s book value of $3.99 is shocking.

It’s rare you find a company of SunOpta’s caliber trading below book value.  But when you do it normally signals a great buying opportunity.

Institutional ownership stands at 60% down from 77%.

However, insiders increased their holdings from 2% to over 11%.

This shows management’s confident about the company’s future.


The company recently restated results for the first three quarters of 2007.  They had an unusual write-down from the Berry Operations.  SunOpta’s earnings are still being impacted by expenses from investigating this situation.

Management appears to have things situation well at hand however.  Results have been restated and those responsible for the problems have been ousted from the company.

To get a clear picture of SunOpta’s profitability, we used all of their financial numbers excluding these extraordinary expenses.

Right now the big company risk is more damage from the restatement.

A number of shareholders have filed a class action lawsuit.  While this could impact results, an agreeable settlement of the case will cause the stock to move higher.

Another risk is SunOpta’s ability to raise capital.  With the tight credit markets SunOpta will be limited in their ability to acquire other natural and organic food companies.

SunOpta’s success also depends on consumer preference for its products.  If customers start buying other natural, organic foods or a competitor’s product, SunOpta’s business will suffer.


SunOpta’s shares are down almost 80% since the end of September.

A big portion of the decline is attributable to their financial restatement.  Not helping the stock was the market’s overall weakness during October and November.

I think this selloff is overdone.

It’s a golden opportunity to pick up SunOpta shares on the cheap.

Just look at other companies in their industry.  SunOpta shares appear hugely misvalued.

Don’t forget book value… SunOpta shares are trading significantly below book value. That means the assets of the business are worth more than the market value of the company.

Now that’s what I call a bargain.

The Price to Sales (P/S) ratios show the same thing.  Competitors are valued significantly above SunOpta.  With revenues and earnings growing faster than the industry, SunOpta deserves a higher P/S multiple.

Another way to compare value and growth is with a PEG ratio.

A PEG compares a company’s P/E ratio to its earnings growth rate.  Based on this valuation metric, SunOpta is trading at a significant discount.

Clearly, SunOpta shares are undervalued by the market right now and due for a big pop.

Once the restatement issue is put behind them, the market value should increase dramatically.  They could even achieve a premium valuation in the market.

Using the industry P/E of 16 and SunOpta’s 2009 estimate of $0.29 per share, a conservative price target is $4.64.

That’s an upside of 145%.


SunOpta (STKL) is trading at $1.89, BUY up to $2.30.

Use a stop loss of $0.95 on this position.

Don’t forget your position sizing and stop-loss rules.


Current Portfolio Stop Loss Triggers

IUSA reached its stop loss.
IXYS reached its stop loss.

Category: PSB Monthly Issues

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