PSB Monthly Issue July 2009
July 2009
SEND THIS BIOTECH STOCK SOARING
Lupus is a chronic, life-threatening autoimmune disease.
This devious malady tricks the body’s immune system into attacking its own tissues. This causes inflammation which leads to swelling, pain, and tissue damage.
Roughly 1.5 million people in the U.S. and 5 million worldwide suffer from some form of lupus. While it can occur at any age, it’s usually found in people aged 15 to 45. Strangely, women are nine times more likely than men to get the disease.
Lupus is frustrating because it’s difficult to diagnose. Many of the symptoms are similar to other diseases. And, they can be there one day and gone the next.
Nobody knows exactly what causes lupus.
Most experts believe some people are born with genes that make it more likely they’ll get the disease. But, this is just a theory.
However, one thing is certain. Lupus can be very painful and sometimes deadly.
While some patients have only mild symptoms, many endure much more severe ones. These unlucky patients often suffer major problems with their kidneys, heart, lungs, nervous system, or blood cells.
Sadly, there is no cure for lupus.
Once you have it, you have it for life. The only treatment is addressing the disease’s individual symptoms. This means lots of different drugs with varying degrees of effectiveness.
But, that could be about to change.
A certain biotech firm may have discovered the lupus “holy grail”. I’m talking about a drug that specifically controls this terrible disease.
Introducing, Human Genome Sciences (HGSI).
Name: Human Genome Sciences Ticker Symbol: HGSI Market Cap: $391 Million Recent Price: $2.88 PSB Rating System 4.3 Stars Raging Revenue: (4.0 stars) Right now HGSI has $150 million in sales. If its products are ultimately approved by the FDA, sales could be huge going forward. Beautiful Books: (4.0 stars) HGSI has enough cash to take it through clinical trial results, filing of FDA applications, and the launch of their late stage products. Stellar Structure: (4.5 stars) Insiders own 7% of shares outstanding which is pretty substantial for a company of this size. In the past six months, two insiders purchased 83,000 shares. Institutional ownership is strong at 67%. Valuation Verification: (4.5 stars) HGSI is down 50% from its 52 week high of $8.00. This provides us with a good entry point and strong potential upside. The stock could easily double or triple on positive clinical trial results for BENLYSTA this month. Meaningful Milestones: (4.5 stars) HGSI made its first product sale ever in 2009. This proves HGSI has the stuff to bring a drug all the way from development stage to full commercialization. |
THE BIOPHARMACEUTICAL BUSINESSES
HGSI is a commercially focused biopharmaceutical company. They develop innovative drugs to treat patients’ unmet medical needs.
The company has a broad pipeline of new drugs. Three promising ones are in late-stage development and moving toward commercialization.
One of these drugs is BENLYSTA, a revolutionary treatment for lupus.
BENLYSTA is an investigational human monoclonal antibody drug. Ok, I know that’s a mouthful.
Here’s my best plain English explanation of how it works.
People with lupus have very high levels of the protein BLyS in their blood. BLyS binds with white blood cells to produce autoantibodies. These are antibodies that attack and destroy the body’s own healthy tissues.
BENLYSTA acts as a kind of “magic bullet”.
It seeks out BLyS proteins in the blood and binds to them. By blocking the receptors on each protein’s surface, BENLYSTA prevents them from binding with white blood cells. This keeps antibody production from going into overdrive.
As a result, the patient’s antibody levels shrink back to normal. No more inflammation, pain, or tissue damage.
It’s pretty amazing science and medicine if you ask me.
The big question now is can HGSI get FDA approval to market the drug? Obviously, they can’t make any money from BENLYSTA unless they’re allowed to sell it.
A recent report suggests the chances for FDA approval are good.
Last month, the company published results from a Phase II continuation trial for BENLYSTA. This was a multi-year follow-up study of patients who took the drug during the Phase II clinical trial four years ago.
The purpose of the trial was to determine how well BENLYSTA worked over time. It also examined whether the drug was safe for patients to use longer term.
And, the results are great.
Patients taking BENLYSTA are showing a reduction in lupus symptoms for four years running. They’re also experiencing less severe flare-ups and fewer flare-ups overall. Plus, the drug is proving generally safe and well tolerated.
These strong results suggest something very important. It means the upcoming results from an important BENLYSTA Phase III clinical trial could be positive as well. And, good results should send HGSI soaring!
But, that’s not all.
In addition to BENLYSTA, investors have other reasons to get excited about HGSI.
Earlier this year, the company announced positive results from two Phase III trials of Albuferon – a new drug for chronic hepatitis C.
The results showed Albuferon is just as effective as the current FDA approved treatment with only half the injections. HGSI will seek FDA approval for the drug this fall. This is another important catalyst that could send the stock rocketing higher.
The company also achieved an important milestone this year.
They sold their first product. HGSI has now proven its ability to take a drug all the way from development to commercialization.
The drug is ABthrax, a human monoclonal antibody drug for treating inhalation anthrax. It targets the toxins released by anthrax bacteria into the blood and tissues.
During the first quarter, HGSI shipped 20,000 doses of ABthrax to the U.S. Strategic National Stockpile. The company generated a cool $150 million in revenue from the sale.
Finally, HGSI has a number of high-potential drugs in development.
Two promising cancer drugs are in mid-stage development. And, drugs for chronic coronary heart disease and type 2 diabetes are in the early stages.
While these drugs are years away from potential production, they are important to the story. A strong pipeline of new drugs is a key driver for biotech stocks.
THE NUMBERS
Let me tell you up front, HGSI does not have a history of revenue and earnings growth. In fact, the company’s been losing money every year for the last decade.
This shouldn’t be a big surprise. Remember, they just made their first product sale this year.
The truth is, losses are typical for biotech firms until they have products to sell. During the development phase, they’re spending huge amounts on research, testing, and launching of new products.
But, here’s the key.
If one or more of their new drugs are successful, HGSI should make gobs of money for years to come. Remember, U.S. patent law gives the maker of a drug exclusive rights for 20 years.
Regarding the company’s financials, it all comes down to this…
The company has enough cash to take it through the clinical trial results, the filing of FDA applications, and the launch of their late stage products. As these events unfold, we’ll either have a huge winner or we’ll have exited the position.
INVESTMENT RISKS
Let there be no misunderstanding. HGSI is a speculative biotech play. As such, it involves some unique risks.
The biggest risk is the results of the Phase III BENLYSTA trial due this month. If they’re disappointing, the stock will probably tank.
Another risk is the FDA may not ultimately approve BENLYSTA. This too would probably cause the stock to dive.
A third risk is the company’s inexperience in manufacturing and commercializing a product. Even if they get FDA approval, there’s no guarantee they’ll successfully market the drug.
POTENTIAL RETURNS OF 247% OR MORE
I’m looking at HGSI as more of a short-term trade than a long-term holding.
The best case scenario is the stock pops on the BENLYSTA Phase III clinical trial results. These results are due sometime in July. If the results are good, the stock could easily shoot up to $10 a share.
If the stock doesn’t move on the BENLYSTA news this month, we’ll soon get another opportunity. HGSI is going to announce further Phase III results for BENLYSTA in November.
If BENLYSTA fails to drive the stock higher, there is another potential catalyst. The company plans on seeking FDA approval for Albuferon this fall. This too could drive a double or triple in the stock.
Remember, this speculative trade is not for the faint of heart. If the BENLYSTA results are disappointing, there’s a good chance we’ll get stopped out on the trade.
On the other hand, if the results are good, we could easily double or triple our money in just a few weeks time.
Buy HGSI now for potential gains of 247% or more.
ACTION RECOMMENDATION
BUY Human Genome Sciences (HGSI) up to $3.16.
Recent price is $2.88.
Use a stop-loss of $1.44 on this position.
Don’t forget your position sizing and stop-loss rules.
CHINA’S LEADING BROMINE PRODUCER
What do oil drilling fluids, flame retardants, paper, perfume, sanitizers, and certain pharmaceuticals have in common?
They all contain the chemical element Bromine.
Bromine is a reddish-brown, volatile liquid at standard room temperature. It bonds easily with many elements and has a strong bleaching action. Its vapors are corrosive and toxic.
Now, you’re not going to stumble across bromine on your nature hike.
It can only be found in compounds with other substances called bromide salts. These are found in salt lakes, seawater, and underground brine wells. Elemental bromine is produced by extracting the bromine ion from natural brine.
More than 650,000 tons of bromine is produced globally every year. Most of it is produced in the US, Israel, and Jordan. Worldwide sales of bromine are about $2 billion annually.
So, why do we give a hoot about bromine?
I’ve got three little words for you… it’s a commodity.
And, who’s hoarding commodities like a survivalist preparing for Armageddon? You guessed it… our old friend China.
China is consuming more bromine than its domestic producers are able to supply. Since China must import a significant amount of bromine every year, bromine prices are rising an astounding 13% annually.
Here’s the key.
China’s domestic bromine producers are making a tidy profit as bromine prices climb higher and higher. And, one in particular is perfectly positioned to capitalize on this situation.
Enter Gulf Resources (GFRE).
Name: Gulf Resources Ticker Symbol: GFRE Market Cap: $64.7 Million Recent Price: $0.53 PSB Rating System 4.6 Stars Raging Revenue: (4.3 stars) Management expects revenue between $98 and $103 million this year. That’s potential growth of 13% – 18% over last year. Beautiful Books: (4.8 stars) Management expects net income to grow 20% – 30% this year. That’s in line with their projected five year earnings growth rate of 25% annually. GFRE’s balance sheet is solid with $30 million in cash, a current ratio of 2.5, and no long term debt. Stellar Structure: (4.0 stars) Insiders own 50% of shares outstanding. Institutional ownership is low at 1%. This stock should soar when institutions and mutual funds start buying shares. Valuation Verification: (5.0 stars) GFRE is seriously mispriced by the market. With a conservative P/E of 10, the shares are worth $2.20. That’s about 315% higher than its recent price. Meaningful Milestones: (4.8 stars) GFRE has made itself into the largest bromine producer in China and the fourth largest globally in less than three years. Last year the company accounted for 23% of all bromine produced in China. |
THE BROMINE AND SPECIALTY CHEMICAL BUSINESSES
GFRE is a leading provider of bromine and specialty chemical products in China. The company is based in Shandong province where 90% of China’s bromine reserves are located. It’s also where most bromine production and consumption takes place.
Bromine has many uses and applications.
It’s a key component in flame retardants, oil drilling fluids, pharmaceuticals, and dyes. Bromine is also used in chemicals for water treatment, agriculture, and papermaking. (You may have used bromine to clean your swimming pool.)
GFRE is the largest bromine producer in China (and the fourth largest globally).
An amazing feat considering they just entered the business three years ago. They produce 34,700 tons of bromine per year, which is about 23% of total domestic production. And, they’re intent on keeping their number one spot.
Here’s how they’re doing it.
It all starts with large bromine resources and a production license.
GFRE has mineral rights on over 23,000 acres of the richest bromine reserve land in China. Their proven and probable reserves are greater than 2 million tons. (They’re not about to run out of bromine anytime soon.)
In addition, GFRE is one of just six companies in China with a government license to produce bromine. The other five produce bromine solely for their own consumption.
The production license is much more valuable than you might think.
You see, the Shandong government stopped issuing new licenses in 2006. In other words, the government has effectively barred new competitors from entering the business. (Talk about your barriers to entry!)
And, that’s not all.
The government is also aggressively shutting down small unlicensed bromine producers. This is creating a major windfall for GFRE. They’re gobbling up these properties like that Japanese guy at a hot dog eating contest.
This acquisition strategy is another key to GFRE’s plan to stay on top.
Over the past two years, they’ve acquired six properties. These acquisitions have increased annual production by a whopping 34,000 tons. GFRE plans on scooping up more of these unlicensed producers this year and beyond.
In fact, they already have their sights set on several juicy acquisition targets.
Management believes these properties could double current production, increase market share, and significantly add to revenue and earnings. Clearly, GFRE has a friend in the Shandong government.
The combination of huge bromine reserves, expanding production capacity, and rising prices can mean only one thing for GFRE. Bigger sales and profits ahead.
In addition to bromine, GFRE manufactures 35 different chemical products. These are used in oil and gas exploration, oil field drilling, wastewater processing, and papermaking.
Exciting things are happening in GFRE’s chemical business.
They’re developing a whole new line of environmentally friendly chemicals.
Last fall, the company introduced environmentally friendly chemicals for oil and gas exploration. And, they were a big hit with customers. In the first quarter, these products made up 20% of chemical business revenue.
But, here’s the best part.
These environmentally friendly products carry a 30% price premium.
Needless to say, producing environmentally friendly chemicals for other applications is a top priority. If these have the same success, look for chemical business revenue and earnings to take off.
Speaking of revenue and earnings, let’s take a look at the company’s financials.
THE NUMBERS
GFRE is growing extraordinarily fast since entering the bromine production and specialty chemicals businesses in late 2006. Revenue has nearly tripled. And, earnings have grown almost six fold.
Just take a look at last year’s phenomenal results.
Top line growth was nothing short of amazing. Revenue jumped a whopping 61% to $87.5 million.
Bromine production nearly doubled from 2007 levels thanks to several newly acquired properties. And, strong sales of environmentally friendly chemicals lifted chemicals revenue by an impressive 18%.
Bottom line growth was even more impressive. Net income skyrocketed 84% to $22.4 million. The huge jump in bromine production revenue and eye-popping gross margins of 40% were behind the gains.
As you can see, the company’s growth strategy is firing on all cylinders.
While growth slowed in the first quarter of 2009, it’s nothing to worry about. The first quarter is typically the weakest for most Chinese companies due to New Year festivities.
And, despite the weak business environment, GFRE posted strong results. The company showed a profit of six cents a share on revenue growth of 7%.
The outlook for the rest of the year is very bright.
Bromine prices are rising on surging demand.
Customers are scrambling to lock in prices before they rise further. This in turn helps drive prices even higher. (A very profitable demand/price dynamic for GFRE.)
Bromine production capacity is expanding.
GFRE is ramping production at a new property that should add 3,000 tons to annual production. They’re also moving to acquire several new bromine producing properties this year.
And, gross profit margins are increasing.
Brisk sales of higher margin environmentally friendly chemicals are driving the expansion. This trend should gather momentum as production of similar chemicals for other industries begins this year. Expanding margins means bigger profits ahead.
For 2009, management forecasts revenue growth of 13% to 18% and earnings between $0.22 and $0.24 per share.
The final piece of the puzzle is a strong balance sheet.
GFRE’s sitting on a cash hoard of $30 million. They’re generating more than $3 million a month in net cash flows. And, current assets cover short-term liabilities by a healthy 2.5 to 1.0 margin.
What’s more, the company has no long-term debt. They recently extinguished it with 21 million shares of common stock. While the transaction is dilutive short term, it frees up cash for acquisitions that should quickly boost revenue and earnings.
As you can see, GFRE is a financially sound company engaging in high growth businesses with strong barriers to entry. This all points to a higher stock price in the months ahead.
INVESTMENT RISKS
With that said, an investment in GFRE is not without risks.
The company depends on a small number of key customers for a large portion of its revenue. The loss of one or more of these customers could harm the company.
Another risk is political, economic, and social uncertainties unique to China. If the Chinese government limits economic reform, it could hurt investments in China.
A third risk is fluctuations in the price of bromine. Since most of GFRE’s revenue depends on sales of bromine and products made from bromine, fluctuations in bromine prices could hurt profitability.
POTENTIAL RETURNS OF 315% OR MORE
An investment in GFRE makes sense for several different reasons.
The company has huge bromine reserves. With more than two million tons of bromine resources, GFRE has plenty of bromine to support its growth for decades.
Bromine prices are rising. The bromine supply and demand imbalance should continue pushing prices higher. And, rising bromine prices should drive GFRE’s revenue and earnings growth.
GFRE’s strategy of acquiring unlicensed bromine producers is expanding production capacity quickly and cheaply. Greater bromine production drives revenue and earnings growth.
The company operates in an industry with a huge barrier to entry. The government’s decision to stop issuing bromine production licenses prevents new competitors from entering the market.
GFRE is expanding production of environmentally friendly chemicals. Because demand is strong, increasing sales of these higher margin products should drive greater overall profitability.
And finally, the stock is completely mispriced by the market. A comparison with its largest competitor shows just how misvalued GFRE really is.
GFRE is expected to grow earnings at 25% annually over the next five years. Albemarle (ALB) is projected to grow at just 6%. Yet, ALB has much higher P/E, P/S, and P/B ratios.
We think GFRE’s extraordinarily high growth rate deserves multiples at least as high as ALB’s.
With a P/S of 1.0 times revenue per share of $0.86, GFRE is worth $0.86. That’s 62% higher than its recent price.
With a P/B of 2.2 times book value per share of $0.66, GFRE is worth $1.45. A potential gain of 173% from its recent price.
With a P/E of 14.6 times trailing earnings of $0.22 per share, GFRE is worth $3.21. That’s about 505% higher than its recent price.
Based on our analysis, the stock’s worth at least $2.20 a share. Buy GFRE now for potential gains of 315% or more.
ACTION RECOMMENDATION
BUY Gulf Resources (GFRE) up to $0.78 per share.
Recent price is $0.53.
Use a stop-loss of $0.27 on this position.
Don’t forget your position sizing and stop-loss rules.
Category: PSB Monthly Issues
