Kamada Looks Cheap As Takeda Deal Creates Value
Nov. 2, 2020 2:11 PM ET | About: Kamada Ltd. (KMDA), Includes: TAK, TKPHF
Zach Bristow
Summary
We believe Kamada looks cheap, as there are long-tailed asset returns from the Takeda deal which the market may be overlooking.
Recent retraction in Kamada's shares on the charts signals a potential dislocation in value and to today's trading.
Our long-term thesis sees this alongside other key differentiators in COVID-19 exposure and the rabies treatment segment, setting a price target of $10.64.
Investment Thesis
We believe Kamada Ltd. (NASDAQ:KMDA) looks cheap at current valuations, and several key developments in the developmental pipeline look yet to be priced in from the market. Whilst the stock seems cheap on a valuation front, investors have shied away from share support, and the stock has given away -84% since September to today's trading of $7.05. We believe that KMDA has unique exposure to the Israeli market, alongside COVID-19 and rabies treatment differentiators, which can create value in the coming years. These points are coupled with key differentiators in these segments that insulate the company from peers on a competitive level. Such differentials include expansion to paediatrics in the rabies segment and focus on a treatment vs a vaccine in the COVID-19 segment. Further, the company has created large value through their latest production arrangement for Glassia with Takeda Pharmaceutical Company (NYSE:TAK). This sees royalty payments at a respectful yield until 2040, thus creating long-tailed asset returns and widening future reinvestment opportunities, which are included into our valuation for the company.
ChartData by YCharts
Catalysts for Price Change
KMDA has completed agreements with TAK on extension of Glassia production into 2021. Glassia is an alpha-1 proteinase inhibitor, indicated for chronic augmentation and maintenance therapy in individuals with emphysema caused by a deficiency of that molecule. Kamada, being the holder of the license applications for the drug, will continue to receive royalty payments on net sales at a yield of 12% until 2025, 6% thereafter until 2040. The agreement sets a floor on royalties to be received of $5 million per year, thus guaranteeing KMDA that minimum yearly from 2022 to 2040. In the base case, KMDA expects a royalty payment in the ranges of $10 million to $20 million per year across this time frame, based on Glassia sales trajectory and projected sales growth. This translates to a range of $180 million to $360 million across this entire period, notwithstanding the potential for future Glassia sales growth above current guidance. Also, considering the early 12% yield to 2025, the company will likely realise greater than $10 million per year over this period. Therefore, KMDA has effectively created high value on the back of this deal, generating long-tailed asset returns via the royalty payments, whilst leveraging COGS savings for future operations.
Further, the company has unique exposure to COVID-19, via their plasma-derived hyperimmune immunoglobulin product as a potential treatment. The company has levered its expertise in this segment to provide investors unique exposure to COVID-19 market potential. What's unique about this exposure is that the company isn't competing in the race for a vaccine, rather a treatment for serious symptoms associated with the illness. The phase 1/2 open trial conducted in Israel has shown promising results in COVID-19 patients with pneumonia who are unventilated. Interim results displayed improvement in 11/12 people of the sample population, within 24-48 hours of treatment. Of this 11, all were discharged from hospital within 4.5 days (median) of the initial treatment. These are statistically relevant numbers and demonstrate the effectiveness for the treatment moving through trial phases. Further, the efficacy and safety data was sound as well, which should improve the flavoring of the next trial phases. Should label acceptance occur within the coming periods, then we anticipate KMDA sales to improve drastically over the coming years, particularly if uptake is considered in major European and other EMEA markets, in light of the recent spike in COVID-19 cases.
Additionally, back in August, KMDA expanded on data for its Kedrab label, for application and safety in use for paediatric rabies cases. The study was completed in the US, and investors immediately saw around 12-15% upside on the back of the news. Kedrab, which was launched in 2018, accounted for over $30 million of sales in 2019, capturing just over 20% market share. We view this recent addition exposes the company to a larger market and will enable KMDA to continue to grab market share in their rabies segment. We view potential sales expansion over on the back of this announcement, particularly as the paediatric portion in this segment remains largely under-exploited.
With these advancements, alongside current operations, we view revenues returning to pre-COVID-19 levels by 2024. We view a large downturn in revenues after 2021 secondary to Glassia restructuring, whereby profitability will continue to expand from that point until 2024 and beyond. Over the coming single-year period, we see FCF growth to $10.52 million, on a healthy margin of around 62%, with gross margins averaging over 30% in the next 4 quarters to FY2021 end. Additionally, following the Glassia deal restructure, and with expected royalty structuring, we view an unloading of margin pressure from reduced revenue costs, offset by reduced operating income.
Valuation
Analysing multiples over the previous segments to today, we see a slight correction in most measures. We believe that the stock seems cheap on this front, where future value in years to come has yet to be priced in. Although the stock has retracted back on the charts since September (discussed later), we view that current levels of trading present a potential entry point for a stock that has retained shareholder value, and created long-tailed asset returns until 2040. Considering the company's ability to reinvest all royalty payments back into the pipeline, or generate additional returns on investment decisions from this cash flow, this must be priced into the valuation also. Therefore, on a multiples front, this supports our thesis for long-term investors at today's trading.
Data Source: Author's Calculations
We see EV/EBITDA of 8.9x as good value vs the median for the sector, alongside a FWD P/E of 19.7x as decent value relative to peers. Momentum on P/E growth also highlights investor expectations over the coming year. The company trades at 15x FCF, not unreasonable and has 6.28% FCF yield, on the high side in our view, good numbers for equity holders. The company only has $0.22 in free cash per share, but P/Sales of 2.3x offsets this point from a value perspective. Additionally, we see P/Book above 1x as value creation for shareholders, thus trading at 1.9x book value is extraordinary in our view. Reasonable double-digit ROIC and ROA of 12.49% and 10.96%, respectively, add weight to the valuation also. Although these numbers have fallen over recent periods, the company has not been immune the pandemic's effect on the markets. However, with high ROIC and ROA, alongside $0.73 per $1 committed to asset growth, we see further upside in the valuation from today's measures. We assign a 1.5x premium to our FWD P/E estimates of 19.7x, relative to our FY2020 EPS estimates of 0.36, thereby creating a price target of $10.64 over the coming 12 months. However, there are threats to this price target based on current market sentiment, as investors can see below.
Further Considerations
On the chats, we've observed a sharp retraction from August/September highs, with a large pullback to today's trading. The longer-term support line has only been realised at today's prices, whereas prior to August, shares had bounced away from the support line 5 times since the selloff in March. The stock didn't break resistance until August, where it shot north with speed, as seen below. Following the huge uptick on the back of KMDA's COVID-19 entry, we postulate that speculators took profits quickly and reallocated capital to the next whisper of a COVID-19 vaccine. We've observed this regularly on charts YTD, particularly in the 2nd quarter, where competition is high within that segment. We can view the pattern of behaviour on the charts below, where the longer-term support line has been formed, with a large dispersal of price returns away from this floor of support. Consequently, we feel that a new level or support or resistance will be formed from here, which will dictate the stocks next move from today.
Data Source: Author's Bloomberg Terminal
As seen on the chart below, there has been a descending triangle setup formed since August, with a flat lower trend line and sharp decline from the upper trend ceiling. This has occurred after a small consolidation towards the end of August, where the stock continued south up until today. We view risks for investors with this setup, as further downside may be imminent should the trend continue. Thus, the current investor sentiment is bearish in our view, which supports a contrarian's thesis for entry at these numbers.
Data Source: Author's Bloomberg Terminal
We've also witnessed these movements on the back of high volatility to the downside, where adequate compensation for this has been questionable. Most recently, the Sortino ratio reached 0.3, which is low in our view, considering record low treasury yields and the flattening of the yield curve. We see this downside volatility as a risk for investors wanting to make an adequate entry decision, and advocate for investors to perhaps wait until downside volatility has settled and the stock finds its range. We see a struggle for pricing range occurring over the next few weeks to months, but feel the market sentiment in the long-term will be bullish. This is especially true in light of the value created with the TRK agreement.
Data Source: Trading View KMDA
What ideally needs to happen is the stock bounces away from the lower support line and regains momentum in favour of the upside. Right now, the bears have it and are driving the stock south with speed. We can see this setup on the charts above, where the current level of support has reached May lows, presenting the risks outlined. On the flip side, in our view, the negatives are offset by several drivers to change. First, considering the value in the recent royalty agreement, rabies segment differentiators and unique COVID-19 exposure. Then, with our current valuations and high ROIC and ROA, this may present as an exciting entry point with a contrarian flavour to ones reasoning. We feel the stock has upside potential in the long term, thus, we believe long-term investors need to keep a close eye on KMDA's story in periods to come.
Additional Risks
There are pipeline risks that apply to KMDA's development story. Firstly, overall failure in the COVID-19 segment would be a blow to shareholders, as we have seen several overcorrections in stocks this year that have either pulled studies or failed on phase 2 clinical data. The market would likely view this in a negative light for KMDA also, especially considering the volatility with COVID-19 players, in the run for a vaccine or not. Furthermore, any disruption to Glassia sales over the next few years will see a lower than expected royalty yield from the TRK agreement. This would impact management's capital allocation, due to changes in the size and timing of the cash flows to be received. Better than expected Glassia sales will offset this point immediately, especially with a double-digit royalty on net sales over the next few years, on the high side. Investors must therefore consider competition in Glassia's operating segment to gain the most insight into extended revenues for KMDA over coming periods. Additional risks to investors lie on the charts, where further movement south in price will eat into returns, increasing downside risk and risk-adjusted return potential. Until recently, volatility to the downside has been high, thereby extending risks to investor's bottom line potential. In this view, should current trends continue, then current investors will see further downside in pricing risk, should recovery take longer than expected. Undoubtedly, we see a large uptick in price offsetting this point.
Credit Summary and Conclusion
The market has punished KMDA recently with no meaningful explanation outside of pricing activity. Fundamentally, the company's outlook remains largely unchanged, although management will provide further insights with Q3 guidance around the corner. The company left the 2nd quarter well capitalised with around $100 million in cash on the balance sheet, with LT debt of just over $30 million. Interest expenses are well covered at over 89x coverage from EBITDA level earnings, whilst total debt/EBITDA is 0.21x. Long-term debt to total capital has remained stable over recent periods, most recently at 2.22x from the Q2 exit, whilst total debt to capital and debt to equity are at 2.97 and 3.06, respectively. KMDA's debt ratio has come down by around 40% YoY, and stands at 2.52 from Q2. On a short-term solvency basis, short-term obligations are covered 5.79x from liquid assets, and the company has adequate liquidity should inventory remain stagnant. Long-term debt to total assets has also come down by around 40% since 2019, at 2.52x, whilst their Altman z-score has gained points to 7.07 from Q2. Therefore, we see the company in good health, with reasonable strength on the balance sheet, and no meaningful drags or pulls on liquidity.
A contrarian flavour to one's thinking would view a potential dislocation in KMDA's value and price. With prices continuing on the down, there may be further downside volatility over the coming weeks and months until shares find their range. Until then, we encourage investors to set up for entry, should the stock see momentum and a large uptick from the current level of long-term support. This would provide a compelling case for entry. Further, the market may be overlooking the value of the long-tailed asset returns that will surmount on the back of the deal with TRK. This must be factored into reasoning also. More news on these developments from Q3 earnings may be the upcoming catalyst to drive shares back north towards August highs. Until then, we eagerly await results from this quarter to provide additional coverage.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in KMDA over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
