Small & Mid-Cap Bulletin - November 2017
Small & Mid-Cap Bulletin - November 2017
Our digital Institutional Small & Mid-Cap Bulletin for professional subscribers offers powerful content featuring a pair of companies not often covered by sell-side analysts. Two stock highlights, one geared toward near-term investors and the other for long-term accounts, offer readers current, unbiased recommendations with in-depth analysis. These monthly featured stocks are among the approximately 1,700 that appear in The Value Line Investment Survey® — Small & Mid-Cap. Tap into Value Line's equity coverage, where you'll have access to complete content, and the ability to create watchlists and alerts based on the featured companies offered in this exclusive bulletin.
Emergent BioSolutions Inc. (EBS)
By Jeremy Butler, Editorial Analyst
Emergent BioSolutions Inc. (EBS) is a global life sciences company that manufactures products to combat accidental, intentional, and naturally occurring public health hazards. The company sells these products to the military and to civilian populations. Products sold and services rendered include vaccines and anti-infectives, antibody therapeutics, devices and lotions, and contract manufacturing services.
EBS has six revenue generating products, as well as a wide array of promising services and products in its pipeline. The U.S. Government is the company’s primary customer, and it provides EBS with substantial funding for product development. Emergent BioSolutions’ first commercial product was BIOTHRAX, which was approved by the Food and Drug Administration (FDA) on January 31, 2002. It was created to be used by the military as a vaccine for anthrax. The company has about 1,100 employees and was incorporated in Delaware in June, 2004. It is headquartered in Maryland.
For reporting purposes, EBS divides its business into four segments. These are Vaccines & Anti-infectives, Antibody Therapeutics, Devices, and Contract Manufacturing. The first three businesses are collectively defined as Product Sales. They comprised 63% of second-quarter sales. The Contract Manufacturing operation contributed the remaining 37%. The latter business, although smaller, provides EBS with a very steady revenue stream.
In the Vaccines & Anti-infectives division, the company sells BIOTHRAX, the only FDA approved anthrax vaccine on the market. It is also developing a second-generation anthrax vaccine (called NUTHRAX), which has so far proved to be more effective than BIOTHRAX. EBS is also working on a vaccine for dengue fever called UV-4B and an intravenous treatment for Burkholderia pseudomallei (a soil-dwelling bacterium found in certain tropical and subtropical regions) named GC-072.
In the Antibody Therapeutics group, EBS has ANTHRASIL, which is used for the immediate treatment of inhaled anthrax; BAT, for treating botulism; and VIGIV, for smallpox. In addition, this division has some very important pipeline products, which are being tested for treating and vaccinating people against the zika and ebola viruses.
The Devices operation sells a skin lotion called RSDL that combats the effects of chemical warfare agents. This unit also has an auto-injector device called TROBIGARD that is used to inject a nerve agent countermeasure. TROBIGARD has yet to be approved by the FDA, however.
Lastly, EBS has a Contract Manufacturing business. This sector provides testing, filling, packaging, and transportation services for products manufactured by large drug companies. It also generates income from contracts and grants obtained from the U.S. Government.
Emergent BioSolutions’ longstanding relationship with the U.S. Government, which dates back to 2000, is key to our reasoning behind an investment in this stock. The government and its various departments should continue to provide EBS with generous funding for research into products that can be used to combat chemical, biological, and non-explosive radiological and nuclear threats, along with natural infectious diseases (such as smallpox and ebola).
Demand for the company’s products and services is expected to increase. Natural disasters caused by hurricanes, earthquakes, wildfires, and flooding have given rise to land- and water-borne diseases. Civilian populations in many parts of the world will need protection against such threats. In addition, there is a possibility that more U.S. troops will be deployed to remote parts of the world, where biological warfare and/or natural infectious threats proliferate. These troops will need protection against such perils. The U.S. already has just over 240,000 active-duty and reserve troops in at least 172 countries and territories.
Finally, the company’s strong cash-flow generating ability, combined with its increasing cash on the books and low debt-to-total capital ratio, provide it with the financial wherewithal to continue making timely acquisitions (see below), which ought to enhance the top and bottom lines.
Emergent BioSolutions has been rapidly consolidating its position as one of the U.S. Government’s major suppliers of vaccines and antidotes for a wide array of diseases. On July 26th, it secured global exclusive rights to industry peer Valneva’s zika vaccine technology. On September 18th, it was awarded a $63 million contract from the Department of Health & Human Services to develop a treatment for cyanide exposure. Later that month, it obtained a five-year contract from the Department of Defense to supply Reactive Skin Decontamination Lotion (RSDL), the only ointment cleared by the FDA to remove and/or neutralize chemical warfare agents from the skin, to all U.S. military personnel. Also, on October 3rd, EBS acquired the rights to market drugmaker GlaxoSmithKline’s RAXIBACUMAB, a prophylactic treatment against inhaled anthrax. Most recently, EBS acquired Sanofi’s smallpox vaccine, the only one to be FDA approved.
EBS was due to report third-quarter earnings soon after this report went to press. We look for second half earnings to be flat and expect the company to report third-quarter share net of around $0.40, compared with $0.43 in the year-earlier quarter. For the fourth quarter, we look for share net of around $0.70, compared with $0.67 in last year’s December quarter. Our share-net estimate for 2017 is $1.45, compared with 2016’s tally of $1.35. We look for a much larger jump in share earnings, to $2.25, in 2018, helped by recent acquisitions.
Over the past five years, sales have been growing at a 9.5% average annual clip, and EBS’ working capital is substantial (about $480 million), thanks to a growing hoard of cash on the books. Free cash flow is also burgeoning (the company doesn’t pay a dividend). Meantime, at the end of the second quarter, the long-term debt-to-total capital ratio stood at a very manageable 29%.
Emergent BioSolutions’ government business and funding provide it with a very stable revenue flow. Generous funding not only allows the company to research and develop products for the military, but it also helps finance research into antidotes for general civilian threats. EBS is fast becoming the go-to company when it comes to vaccines, treatments, and antidotes to a number of viral and radiological threats. Currently, the company is working on a vaccine against the most deleterious effects of radiation. This was prompted by saber rattling from North Korea’s regime. Of course, relying heavily on one customer, even if that customer is as large as the U.S. Government, adds an element of risk.
The proliferation of viruses such as zika, ebola, and influenza among an increasingly interconnected global population, in addition to the prevalence of bacteria from water pollution, and poisons from fire damage of melted household products (such as asbestos, rat poison, and plastics) ought to increase demand for EBS’ products. The stock recently traded at a fair P/E multiple. We think this equity provides investors with a growth catalyst for a well-rounded portfolio.
At the time of the above article’s writing, the author did not have positions in any of the companies mentioned.
Yext, Inc. (YEXT)
By Kevin Downing, Editorial Analyst
Yext, Inc. (YEXT) is an 11-year old software company that went public in February of 2017. Its solutions let businesses update data for customers about physical store locations across all leading Internet search platforms and social media outlets. Clients upload information to Yext’s cloud database (including name, description, category, forms of payment accepted, location, phone number, and hours of operation), and these facts get disseminated instantaneously across more than 100 third-party services. These services include conventional search engines Google, Yahoo, and Bing; GPS services Apple Maps and Google Maps; social media outlets Facebook, Instagram, Foursquare, and Yelp; and voice-activated virtual assistants like Apple’s Siri and Google’s Assistant. Refers
Yext’s major enterprise customers include AutoZone, Ben & Jerry's, Best Buy, Citigroup, Denny's, Farmers Insurance Group, H&R Block, Infiniti, Marriott, The Michaels Companies, McDonald's, Rite Aid, and others. Sales to small businesses represented less than 20% of total revenue during the fiscal year ended January 31, 2017, and that figure should decline further as the enterprise channel expands.
At present, the vast majority of intelligence services compile information on businesses using Web crawlers and user-generated content. However, this “best guess” data can be inaccurate, out of date, or absent entirely, which often results in missed sales opportunities and customer dissatisfaction. Too, when a store has conflicting information on the Web, this typically results in inferior positioning within search engine results.
If a business wanted to make sure all its information was accurate without using Yext, it would need to manually coordinate with dozens of apps and social media outfits. This undertaking would be time consuming at best and impossible at worst, depending on the number of store locations, nature of the information, and platform being targeted. Indeed, according to management, it is not possible to simply call up Apple and tell them to update a fact on Siri.
Further, the type of information Yext’s software is capable of feeding into these platforms is generally more robust than can be provided via conventional means. Clients can use Yext to provide photos and video, announcements, limited time offers, featured products, reviews, menus, and even more specific information like whether a hotel allows pets or a doctor accepts certain insurance plans.
Yext doesn’t have much in the way of competition at present. There are some lower cost outfits with similar features (Synup and Uberall), but only Yext is partnered directly with major search engines and digital assistants, which prefer to get their information from one company, not multiple sources. Yext realized this early on and, consequently, was able to establish key relationships with search engines and other partners. This makes the company uniquely positioned to take advantage of the rising popularity of voice search. According to Google, 20% of search queries on its mobile application and on Android devices are voice searches. Too, half of U.S. teens and 41% of U.S. adults use voice search daily.
Aside from this trend, the company’s primary means of revenue growth is adding more locations to its network. At present, there are more than 100 million business locations in Google Maps, of which Yext has around a million in its system. According to the company, this represents an estimated $10 billion addressable market, and only includes location data, not other features, which the company charges separately for.
Thus, adding new capabilities is another growth vehicle for Yext. The company’s newest functionality, Yext for Food, was launched in mid-October and enables robust information about restaurants, bars, and the like to appear in search results and on Web sites such as Yelp. Users can enquire about specific menu items like “tacos near me” and Yext will search menus in its system and display stores that have the item. Attributes such as price range, dress code, drink specials, and outdoor seating can also be made available. The company believes that the more types of data it manages for customers, the more likely they will be to renew their subscriptions.
The third pillar of Yext’s growth strategy is building out the sales team. The company recently opened its first office in Japan, marking the first time the platform will be available to businesses headquartered in Asia. This market has significant potential for expansion, owing to the high level of mobile adoption and the rising popularity of virtual assistants in that region. At home, Yext plans to aggressively expand its sales capacity in the second half of the year.
Recent Results and Guidance
Second-quarter revenue of $54.6 million increased an impressive 38% year over year, slightly more than the 37% achieved in the first quarter. The gross margin rose 480 basis points to an all-time high of 74.1%, as the higher top line drove fixed-cost leverage. Operating expenses increased 58% due to efforts to expand the sales team and geographic footprint. The non-GAAP net loss of $0.13 was in line with share-deficit guidance of $0.12 to $0.15, and compares favorably with a $0.22 loss in the prior year’s fiscal second quarter.
Meanwhile, the company announced that two of its reseller partners, Dex Media Inc. and Yellow Pages publisher YP Holdings LLC, merged. Combined, the two entities accounted for less than 10% of 2016 revenue, but both were among the top-10 largest customers. Yext signed an agreement with the combined company, but the impact of the merger is expected to lower the top line by 1% this fiscal year.
Nonetheless, management still increased its revenue guidance for the full year by half a million dollars, to $169.5 million to $170.5 million, which would represent roughly 90% year-over-year growth. The tight range implies good visibility as the company goes through its seasonally strong second half of the fiscal year. The non-GAAP net loss for the full year is expected to land between $0.50 and $0.52. Importantly, Yext plans to be cash flow positive by the end of fiscal 2018.
Despite recording strong top-line growth in its first two quarters as a public company, Yext’s shares have traded in a fairly tight range. We think investors may be underestimating the company’s favorable positioning in this burgeoning market. Yext is the clear leader in the space, and its incumbent relationships with intelligence services like Google and Siri ought to keep it that way. The fact that Yext software helps ensure brick-and-mortar outfits don’t lose customers and sales speaks to the importance of its services. We have confidence in the company’s ability to continue developing useful functionality. An expanding sales team and solid prospects for international expansion are other elements of our positive investment thesis. Like most newly listed technology stocks, YEXT carries significant risks. However, patient, venturesome investors may want to take advantage of the stock’s reasonable valuation and attractive long-term growth prospects.
At the time of the above article’s writing, the author did not have positions in any of the companies mentioned.
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