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Lantheus Holdings, Inc. (LNTH)
By Jeremy Butler, Editorial Analyst
Lantheus (LNTH) is a global leader in the manufacture and marketing of medical imaging agents, such as contrast agents and radiopharmaceuticals. These products are used by doctors to diagnose and treat cardiovascular disease and related ailments. The agents (or “markers”) are used in conjunction with magnetic resonance imaging, nuclear imaging, and echocardiography. Lantheus sells its products to hospitals, clinics, imaging centers, group practices, radiopharmacies, and group purchasing organizations. The company has operations in the United States, Puerto Rico, Australia, and Canada. It also has distribution networks in Europe, Asia, and South America. The company has about 480 employees and is headquartered in North Billerica, Massachusetts.
Lantheus has three major commercial products and seven secondary commercial products. Its top-seller is Definity, an ultrasound imaging agent (a clear sterile liquid). When activated by the Vialmix apparatus (a medical device specifically made for Definity), the fluid becomes milky looking. It is then injected into the left ventricle of the heart where, using an ultrasound machine, physicians can see ventricle wall motion abnormalities. The fluid thus enables heart surgeons to significantly improve their assessment of heart function. Launched in 2001, Definity has been used on 6.7 million patients throughout the world and is the leading ultrasound imaging agent based on revenues and usage. At the end of the third quarter, it had 79% of the market for contrast agents in U.S. echocardiography/ultrasound procedures (the two go hand-in-hand). Definity generated 45% of Lantheus’ third-quarter revenues.
The company’s second-best seller is TechneLite, which garnered 34% of third-quarter sales. This medical device is about the size of a coffee can and is used to make Technetium. Technetium is created from the radioactive decay of Molybdenum 99 when mixed with an alumina powder in the TechneLite device. Technetium is a radioisotope that is mixed with a saline solution (or two of Lantheus’ other imaging agents: Cardiolite and Neurolite), and then injected into a patient, where it binds to specific organs or tissues for a set period of time. This allows sonographers, physicians, and organ specialists to see whether or not said organs or tissues have abnormalities and, if so, what kind of abnormalities. Both the device and the imaging agents are made by Lantheus and are sold to customers that specialize in nuclear imaging. Clients include radiopharmacies, such as Cardinal Health, United Pharmacy Partners, GE Healthcare, Triad Isotopes, and Isologic. At the end of September, LNTH had a 28% share of this market. Mallinckrodt (MNK) is Lantheus’ major competitor in this field.
The third major product is Xenon. This is a radiopharmaceutical gas inhaled by patients to assess pulmonary abnormalities and to image cerebral malfunction. The gas can be detected using magnetic resonance imaging equipment. Xenon generated 9% of third-quarter sales. Lantheus is the leading supplier of this critical agent to the domestic medical marketplace. The company’s other seven products are imaging and/or contrasting agents, which are basically dyes that are injected into the bloodstream to detect irregularities in the vascular system. Two of these agents are Cardiolite and Neurolite. Combined, these seven agents tally the remaining 12% of sales.
After going public with 30 million shares at $7 a share in May, 2015, Lantheus began the business of trying to post an annual bottom-line profit. In the second quarter of 2015, expenses related to getting operations up and running on a broader commercial basis sunk expectations of earnings. But in the second half of that year, expenses tapered off, allowing the company to post a second-half share-net tally of $0.31. Lantheus continued its profitable growth pattern in 2016, putting up share earnings of $0.71 for the first nine months of the year. We are looking for 2016 share net of $0.85 on sales of $300 million. Both these figures are expected to rise in 2017, as LNTH garners more clients, signs more multiyear contracts, and gradually raises prices in this fast-growing niche of the medical device sector.
As can be expected from a small, fast-growing company in a highly capital-intensive industry, the long-term debt level is high (at $294 million as of September 30th). However, this figure has receded from $400 million, where it stood at the end of 2014 (when the company was privately held). During the third quarter, the company had a stock offering to raise $40 million, which it used to pay down more debt. Meantime, working capital has been rising (from $32.7 million at the end of 2014, to $71.4 million at the end of September (which included cash assets of $53 million).
The medical imaging and testing sector is recession resistant. Moreover, Lantheus has capitalized on a niche in this sector that has little competition (besides Mallinckrodt). As a result, we expect the entity to be able to gain market share and raise prices as it garners more contracts. Lantheus recently signed lucrative long-term supply and distribution agreements with subcontractors to ensure efficient delivery of its products to an expanding global marketplace. In addition, an aging global population is requiring a greater number of medical imaging and testing procedures. Lantheus is in the forefront of developing fluids for permitting medical professionals to view a greater number of ailments within the human body. These fluids, specifically Definity, along with the medical device, TechneLite, are likely to be in increasing demand.
The stock is gaining the increasing attention of institutional investors. Trading volume in the stock has been increasing, and short selling decreasing. As of March 21st, Avista Capital Management (the private equity firm that took Lantheus public in 2015) owned 58.6% of the stock, T. Rowe Price had 12.2%, and Wellington Management, 9.9%. Since then, such institutional luminaries as Vanguard and BlackRock have taken positions. The potential percentage price gains in this equity are considerable, in our opinion. We view this issue as undervalued, given the increasingly firm realization that share net for 2016 is expected to tally $0.85.
At the time of the above article’s writing, the author did not have positions in any of the companies mentioned.
AXT, Inc. (AXTI)
By Kevin Downing, Editorial Analyst
AXT, Inc. (AXTI) manufactures high-performance semiconductor wafers in China, but is headquartered in California. A semiconductor is a substance (which could be an element, such as silicon, or a chemical compound, like gallium arsenide or indium phosphide) that has lower resistance to the flow of electricity in one direction than another, which makes it essential in creating smaller and more powerful electronic devices. Most of AXT’s products are used as the base semiconductor material in chip fabrication, but compared with the ubiquitous silicon, they are able to withstand higher heat and can execute more demanding tasks. Being domiciled in the United States, AXT adheres to strict product-quality standards and has access to U.S. capital markets, but manufacturing costs in China are lower than at comparable facilities in Japan, Europe, and the United States. The company’s primary competitors manufacture in Germany or Japan, and since they are typically private or divisions or larger, publicly traded entities, it is not necessarily easy for them to copy AXT’s business model in this niche.
Historically, most of the company’s revenue has come from sales of gallium arsenide (GaAs), a base semiconductor material used in smartphone/TV backlights, signage, autos, and lighting, as well as amplifiers and switches found in wireless devices. Since 2015, however, indium phosphide (InP), which is used in fiber optic networks and data center gear, has become the primary money maker, as its general need has increased considerably.
All of AXT’s manufacturing occurs in China, where facility and labor costs are lower compared to competitors’ operations in Japan and Germany. The company has partial ownership (ranging from 20% to 83%) of 10 China-based raw material producers. This diversified supply chain provides pricing advantages, reliable supply, and short lead times. AXT buys materials produced by these joint-venture partners for its own use, and profits from sales they make to third parties (sometimes competing wafer makers). Thus, around one-quarter of total sales are from raw material products.
In addition to supply chain advantages, the company believes its diverse product offerings and ability to meet customers’ unique design specifications are differentiating factors. Moreover, the customer base is relatively diverse, with only one client representing more than 10% of total revenue in the most recent quarter, and the top five customers making up 38%. From a geographical standpoint, roughly two-thirds of revenue comes from the Asia/Pacific region, 20% from Europe, and the rest from the United States.
The global buildout of fiber optic networks is expected to be the main driver of indium phosphide volumes for the foreseeable future. Fiber deployments relieve network congestion, boost download speeds, and help facilitate proliferation of cloud computing, the Internet of Things, and video streaming. According to Research and Markets, global optical transceiver (chips that transmit and receive data using optical fiber) volume is expected to advance at a compounded annual growth rate of 16.3% from 2016 to 2020.
Recent and upcoming capital expenditures from AT&T will likely contribute to that end. The telecom giant looks to install fiber-to-the-premises (home or business) equipment capable of delivering, by the end of 2019, faster data connections to 14 million residential and business customers, up considerably from around 2.6 million homes at the end of 2016. Dycom Industries, a deliverer of maintenance and installation services to telecom providers, is seeing other telecoms deploy these speedy fiber networks to more cities. A number of projects are also reportedly under way by carriers that accepted money from the FCC’s Connect America Fund, a project tasked with deploying fiber deeper into rural America.
Taking a look overseas, although the rate of fiber-to-the-home expansion in China has likely peaked, overall deployments should continue to grow for the next five years. Meanwhile, infrastructure buildouts in other emerging markets, such as India, combined with next-generation optical equipment growth in developed regions, are expected to be enough to pick up China’s slack.
The company currently benefits from data center buildouts and the ongoing transition to ever-faster data speeds. Too, although next-generation and 3D capable smartphones are still in their infancy, it’s possible that indium phosphide will be the material used to make some of the chips these devices run on. These are promising potential long-term growth vehicles for AXT, but visibility is cloudy as to when further developments will be available.
AXT is coming off a solid third quarter where earnings per share of $0.07 exceeded Wall Street’s $0.04 consensus forecast. Revenue of $21.9 million beat the high end of the $20.5 million to $21.5 million guidance range, growing 7% sequentially and 19% year over year. Stronger-than-expected demand for gallium arsenide was the primary catalyst.
The company experienced some weakness on the indium phosphide side, though, owing to less end demand in China. That market has taken a pause after two years of strong growth. The headwind, while modest, likely remained in the fourth quarter. Demand is expected to normalize in 2017.
The raw materials business experienced pricing pressure, causing revenue from joint ventures to drop around half a million dollars year over year in the third quarter. Reportedly, pricing for raw materials gallium and germanium has stabilized somewhat. Sensing a bottom, customers likely pulled forward purchases to build inventory of low-cost raw materials. It will probably take another quarter until supply and demand balance out.
Elsewhere, the gross margin of 34.6% was the highest it’s been since the first quarter of 2012; up significantly from last year’s third-quarter result of 25.1% and the prior quarter’s 29.4% figure. The company said revenue growth drove operating cost leverage. Other factors were a mix shift toward relatively lucrative InP wafers and more-efficient manufacturing improving yields.
Guidance for the fourth quarter calls for the top line to land between $18.5 million and $19.5 million, which compares with $18.1 million in the prior year’s fourth quarter. InP revenue should be positive overall, as fiber-to-the-home deployments and data center buildouts overcome the aforementioned weakness from China. However, this will likely be offset by the raw material headwind. Overall, earnings per share should come in between $0.02 and $0.04 a share.
AXT appears well positioned to take advantage of increased fiber buildouts and spending on next-generation data centers. Although quarterly results will likely be uneven as the market for InP products is still developing, we think the long-term potential is worth considering. Concerns over customers’ inventory adjustments and raw material prices appear to be holding the shares back, and may well continue to do so for the next few quarters, but we look for these drags to abate eventually. All told, only patient investors willing to withstand price volatility should consider this small-cap equity.
At the time of the above article’s writing, the author did not have positions in any of the companies mentioned.