Picking small-cap health care stocks can be a pretty iffy endeavor. With the science unclear until the results of various clinical trials, it’s extremely difficult to get a reliable valuation of any of these companies. And a look at company balance sheets is rarely much help, as a lack of current revenues doesn’t necessarily mean that they aren’t right around the corner for the patient investor.
However, that doesn’t mean fundamental analysis of small-cap health care companies serves no purpose. With the Small-Cap Stars methodology comes the ability to spot those companies that operating in the way previous successes operated before them. No one can accurately predict which drugs are going to prove effective (or at least, if they can, they must be astonishingly wealthy by now), but one can pick out those companies that are placing themselves in the best position to make the most of what comes.
Horizon Pharma (HZNP) is one such company. This Small-Cap Star has been making waves thus far in 2014, climbing some 80 percent since the start of the year. This comes despite a rough go of it for most of the rest of the biotech industry, with the iShares NASDAQ Biotechnology Index ETF (IBB) up just under 2.5 percent and the SPDR S&P Biotech ETF (XBI) down just over 1.25 percent over the same period.
So, why is Horizon bucking the trend for small-cap pharmas in 2014?
Simply put, money. For starters, Horizon’s currently got three drugs on the market, which is three more than most small-cap biotech companies have. Horizon currently boasts Duexis®, which combines ibuprofen and stomach acid-reducer famotidine. The drug is designed to provide pain relief for chronic pain conditions like osteoarthritis and rheumatoid arthritis while reducing the potential for developing upper digestive ulcers. The company also has RAYOS®, a delayed release tablet that delivers a dose of prednisone and can be used in treating a wide variety of inflammatory conditions.
Finally, Horizon acquired the U.S. rights to Vimovo from AstraZeneca (AZN) in November of last year. The drug, which is also a combination of pain relief and a stomach acid reducer to limit the development of ulcers among chronic pain sufferers. The acquisition of the drug was likely connected to the fact that it overlaps with the same patient population as Duexis.
The practice of examining a balance sheet for a small-cap biotech can often be a fairly empty exercise. In many cases, companies go years without any revenue as they go through lengthy clinical trials, making it difficult to suss out where they’re headed from a look at the company’s basic accounting. However, the next step in that life cycle actually involves money coming in.
A look at Horizon’s finances shows a pretty clear picture of a company on the rise. The company’s most recent quarter marked the fifth straight quarter where Horizon grew revenues, with its $51.93 million in net sales representing a nearly 500 percent year-over-year increase from Q1 2014’s $8.69 million and more than double the last quarter’s $23.1 million.
A look at the full-year numbers make the picture even clearer, with revenue increasing 50-fold from 2010 to 2013 and full-year 2014 guidance calling for them to more-than double again this year.
Digging even deeper, Horizon compares even more favorably to its competition if you look at a DuPont Report on the stock. The DuPont System of analysis breaks return on equity (ROE) into three separate components to better analyze what this key component means. And, in the case of Horizon, the results point towards a strong company with a solid fundamental base.
Horizon’s ROE is significantly ahead of most of its competitors despite the fact that its equity multiplier is way below industry average. This is due, at least in part, to the fact that the company is significantly better than industry average in terms of its net margin, a very bullish sign. What’s more, a look at the same metrics over time shows that net margin and ROE are both trending up dramatically while asset turnover is trending towards the industry average (at industry average is considered ideal).
However, when considering the Small-Cap Stars methodology, one of the key factors in examining biotech stocks is the rate at which the company is reinvesting profits and cash. In short, small health care companies need to stay ahead of the curve, pumping resources into developing or acquiring new therapies and properties.
And as such, Horizon’s acquisition of Vidara Therapeutics in March would also be a potentially strong indicator of a company poised to make a move. By shelling out $660 million and in stock and cash, Horizon was able to perform a reverse merger that acquired the rights to a bioengineered form of interferon called Actimmune, which is used to treat severe, malignant osteopetrosis and chronic granulomatous disease, which Vidara had previously acquired from InterMune (ITMN) .
What’s more, the deal allowed Horizon to relocate itself to the tax haven of Ireland, which has become an increasingly popular location for pharmaceutical companies. Horizon released revised guidance based on the move that estimated 2014 FY revenues of $250 million to $265 million, well ahead of the previous consensus estimates of $218 million from a Reuters poll.
The news, which hit the markets on March 19, prompted a 17 percent jump in the company’s stock that eventually carried it to a 52-week high of $18.30 a share on March 21.
In the end, Horizon Pharma is one example of where the Small-Cap Stars system of analysis can work in one's favor, with the stock at just $7.62 at the start of the year and sitting at over $13.50 a share now. And, should Horizon continue hitting its guidance, it's possible that the stock's headed even higher.
DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer