As a fundamentals-based investor, I’m only attracted to the small-cap biotech sector once companies have either broken into profitability, or have technology that has been proven in the field. Unfortunately, most early-stage healthcare businesses do not fall into this camp, since they tend to rely on the success of a few drugs that are still progressing through clinical trails. As such, I’m delighted this week to recommend a £16m market cap biotech company, which is profitable, pays a dividend, possesses no debt and is trading at an attractive valuation.
Gamble of the week: Theratase (THE: 44p)
Theratase produces high-quality enzymes using sophisticated extraction and filtration techniques from naturally occurring substances, such as horseradish roots, fungus and bovine intestines. The enzymes are sold to many of the world’s largest healthcare companies, who incorporate them into their diagnostic procedures – such as monitoring blood-sugar levels in people with diabetes.
Theratase enjoys an 8% share of this $120m market for diagnostic enzymes. Admittedly, the single-digit growth rates are not turbo-charged, but the sector does provide a rich seam of cash that can be used to invest in higher-growth opportunities.
One area that’s developing is the inclusion of the company’s enzymes within the much larger and faster-growing therapeutic market. This sector already accounts for around a third of current turnover. The most important territory for the group’s pharmaceutical products is the Far East, where the enzymes are already used in anti-inflammatory and digestive aid products.
Another application, which is still at an early stage but is a potential blockbuster, is the use of enzymes in the treatment of Sepsis. AM-Pharma BV (in which Theratase owns a 9% stake and supplies the active ingredient) is developing this new Sepsis drug, which, if successful, could become a £1bn product. The results from phase two clinical trials are presently being assessed, with findings due shortly. Although operating in the mature diagnostics sector, Theratase is a science-rich business with a strong market position. Moreover, it has attractive long-term growth opportunities in incorporating its sophisticated enzymes within future drug treatments. Consequently, from a fundamentals perspective, I would value the stock on a conservative 13 times p/e multiple for 2006. KBC Peel Hunt estimates an adjusted earnings per share (EPS) of 4.5p and 5p for this year and next, which would generate a fair value of 58.5p, representing an upside of 33%.
The 4.5p earnings estimate appears to be very achievable, since Theratase delivered EPS of 2.3p (27% higher than last year) at the interims. Sales and profits tend to be weighted towards to the second half, with 2.9p EPS being achieved in 2005.
Recommendation; BUY at 44p (market cap £16m)
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