TPS Trade Alert – July 22, 2015
Recommendation:
Buy 22nd Century Group (NYSE: $XXII) up to $0.95 per share.
The Opportunity:
Biotechnology usually scares us off. We don’t like to invest in complicated things we don’t understand, and biotechnology definitely gets complicated.
But we’ve found a small company that is taking complicated science and using it to achieve a simple result. Getting rid of the nicotine in tobacco.
Not by straining, filtering, or altering the cured leaves, but by actually changing the plant itself.
The company is tucked away in a small town in upstate New York best known for hockey players. It has 128 patents, 52 pending patents in 96 countries, a valuable licensing agreement, and an intriguing mission. It wants to reduce the harm caused by smoking.
22nd Century Group Inc. $XXII uses genetic engineering and breeding techniques to lower the nicotine levels in tobacco plants. It has been a publicly traded company since early 2011. The firm manufactures smoking cessation products and modified risk tobacco products. Current brands include Red Sun and Magic.
Red Sun is positioned as a super-premium cigarette and is marketed online. The company is also setting up distribution through independent distributors in New York City, Los Angeles, San Diego, Las Vegas, Boulder, and Portland.
But the immediate opportunity lies outside the U.S.
22nd Century has just launched its MAGIC 0 cigarette in the UK market, with distribution in 150 specialty tobacco shops in England, Wales, and Scotland.
The valuable licensing agreement is with the world’s second largest tobacco company, British American Tobacco Company $BAT. In the fall of 2013, 22nd Century entered into a 4-year global research license agreement with BAT that grants access to selected patented technology. This agreement provides an option for the two firms to enter into a commercial license.
In the works is X-22, a tobacco-based botanical prescription aid to help people stop smoking. The company needs funding for this, and is looking for a joint venture partner to help cover expenses for a Phase III clinical trial.
Trade Rationale:
What we need to see at 22nd Century is quite simple… more revenue and less expense.
In 2014, the company lost $15.95 million. A much improved performance from 2013, when it lost $26.15 million.
But 22nd Century needs to light up revenues. It needs more sales.
The good news… quarter over quarter revenue is up by 16%. We’re moving in the right direction.
The balance sheet also shows some favorable trends… growing assets and reduced liabilities. Even when you completely strip out the always suspicious intangible assets, things are looking up.
On the downside, cash flow is ugly, and the company took a hit on general and administrative expenses in the first quarter of 2015.
What happens with sales in Spain will be important.
The MAGIC 0, cigarette, marketed as “the world’s lowest nicotine tobacco cigarette,” is on sale in more than 1,100 locations in Spain. The company claims sales are exceeding expectations, and the number of retailers should more than double by year’s end.
Momentum in Spain, coupled with a decent launch in the UK, could easily translate into significantly higher European sales.
Investment Risks:
The big risk is the absence of a market… What if it turns out people actually don’t want to smoke cigarettes without nicotine?
Are there enough people who either can’t or won’t stop smoking who will keep smoking a no or low nicotine cigarette?
Perhaps the best answer comes from the beer business. We have Sharp’s from Miller and O’Douls from Budweiser.
22nd Century also needs to strengthen its retail distribution here in the States. Without it, growth will be slow. A key challenge: no war chest to pay for marketing.
There are global opportunities beyond Europe it needs to lock in. This is why it’s trying to get into China, and other Asian markets, where people tend to smoke like chimneys.
22 Century has plenty of irons in the fire. Each one of them is focused on selling more products to grow revenue.
What we like is the diversity of activity, and the number of different opportunities being pursued. This is not one of those biotech companies where you bet the farm on one “make it or break it” like FDA approval.
Potential Return:
300% or more.
In the spring of 2014, XXII was trading at just over $5.
We believe 22nd Century can regain lost ground, and conservatively can trade at $2.50-$3.00 within the next 12 months.
What will drive this share price growth is a combination of the company’s ability to manage expenses, and to monetize retail activity in both the Spain and UK markets.
From a technical perspective, when the stock moves above a resistance level of $2.31, it should be in a good position to run up into the low threes.
It has rebounded recently from a recent low of 65 cents and we believe this is a good time to buy.
Key Facts:
Company: 22nd Century Group
Ticker: XXII
Recent Price: $0.74
Buy Up To Price: $0.95
Market Cap: $69.21 million
Avg. Daily Volume (3 month): 565,000 shares
Chart:
Category: TPS Trade Alert
