Investing in new technology is always risky, but sometimes incredibly lucrative. For that reason, I want to tell you about a tiny genetic testing firm that I've come across. This small-cap stocks has some impressive offerings in the medical field, and I think it's trading at a substantial discount. All told, I suspect that the company could deliver gains of around 35%. Here's why…Myriad Genetics (NASDAQ: MYGN) makes genetic-based tests that help to predict a person's chances of developing certain types of cancer. Their first and most important product is BRACAnalysis, which is the primary revenue generator. BRACAnalysis is a test that looks for genetic mutations that increase a woman's likelihood of developing breast or ovarian cancer.
Myriad also offers tests that assess the risk of developing colon cancer (COLARIS), prostate cancer (PROLARIS), chemotherapy acceptance (TheraGuide and OnDose 5-FU), cancer progression (Prezeon), and skin cancer (MELAIRS). The company markets its products through an internal sales force, and currently sales are only in the United States.
A glance at the valuation on this stock against its “investment trinity” characteristics – growth, competitive position, financial health – shows a huge disconnect, and Myriad Genetics looks like a potentially solid investment.
Compound annual revenue growth since 2005 has been over 21% on a “per-share” basis, and opearting income has doubled in each of the past 3 years. Myriad continues to have growth avenues. BRACAnalysis should continue to benefit from new guidelines for obstetricians and gynecologists that recommend routine testing for genetically influenced cancer risk. Additionally, Myraid is planning to launch BRACAnalysis into Europe within the next 2 years.
Some analysts believe that the predictive breast cancer market could be an $800 million global opportunity, which would represent a significant upside for Myriad's current $350 million in revenues.
The company's other products should also contribute to future growth. PROLARIS was just launched this year, and aims to grab a chunk of the $270 million prostate cancer prognosis market. Prezeon tests for mutations in a gene that is commonly mutated in cancer sufferers – management estimates the market for this test to be significant. OnDose presents a potentially lower cost, higher effectiveness, and lower side effect treatment for numerous cancers than existing options.
Finally, Myriad looks to launch one new test annually over the next several years. While there are varying opinions of the likelihood of success, the potential at least is there for significant additions to revenue.
There are other things to be excited about, too. Myriad spun off its drug development arm about a year ago. This division had been responsible for the combined company's unprofitable results for many years. Without it, MYGN is a high-margin (39% operating margin), ccash flow producing machine (nearly 40% free cash flow margin). The stand-alone entity can now re-invest its cash into developing new products, entering into new markets, or returning capital to shareholders.
The last, in fact, is already in action, as Myriad has announced a $100 million stock buyback for 2010. At current prices, this seems like a smart thing to do and should reduce outstanding share count by 6% or more.
There may be another motive, as well. With the new company's high margins, great cash flows, and stellar balance sheet (almost $400 million in cash and no debt), Myriad Genetics makes a pretty attractive acquisition candidate for a large pharmaceutical company.
What about competitive position? One of the great things about investing in the pharmaceutical sector is the protection provided by patents. This certainly applies to Myriad and BRACAnalysis. It holds 23 patents related to the BRCA genes that protect BRACAnalysis from competition, granting Myriad a legal near-monopoly in this business. Similar patents surround its other products, although they are considered weaker protections and in markets that already have established competitors.
Put all of this good news together with a very cheap valuation and you have a compelling investment story. At around $14.84, Myriad Genetics trades at an enterprise value to earnings (EV/E) ratio of just 9, and an earnings yeld (operating earnings to enterprise value) of nearly 12% – quite cheap against what are great investment characteristics. Against projected (June) 2011 results, the forward earnings yield is over 13%.
For comparison, this is a stock that has traded at an average earnings yield of just 2.4% over the past 3 years.
So what are the problems leading to this valuation? The biggest headline risk is the loss in court against the ACLU back in March, where a number of claims in 7 of Myriad's BRACAnalysis patents were ruled invalid. Myriad plans to appeal, of course, and the other patents remain unchallenged. However, if the appeal is not successful, competitors may be emboldened to attack the remaining protections.
Also, there is legitimate concern over the company's performance for the last year or so. Myriad has consistently disappointed the Street with below expected revenue, earnings, and guidance. In the most recent quarter, revenues were up just 5%, and operating earnings actually declined 6%. There has been rumblings that BRACAnalysis has reached near-saturation of its market, and that the other tests have not been particularly successful at gaining market share or acceptance. For a firm with such apparent growth potential, management's results have not been stellar. Their excuse of a weak economy and high unemployment doesn't really fly, not for something as serious as cancer testing.
That said, I believe the positives far outweigh the negatives, making Myriad Genetics a good investment at current prices. A lot of negativity is baked into the stock, and any kind of favorable news (such as a successful patent appeal or a return of growth) should bump the stock nicely.
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