Avid Bioservices Inc (CDMO)

[cheynew]

Seeking Alpha article just published

Avid Bioservices: FDA CGMP Stringency Provides Stable Long Outlook

Aug. 11, 2021 3:09 PM ETAvid Bioservices, Inc. (CDMO)CDMOP
Another Mountain's Rock Investing profile picture.
Another Mountain's Rock Investing
702 Followers
Bio

Follow
Long-Term Horizon, Tech, Growth

Contributor Since 2020

Hello, I am an individual investor with an interest in bringing diversification of viewpoints to stock analysis and investing. This brings to point the Japanese proverb ???? -ta-zan-no-ishi- which translates to "another-mountain's-rock" and denotes the importance of diversifying the sources of your knowledge in order to gain the advantage of multiple perspectives. Further, a rock represents the foundational aspects of the world a mountain supports, signifying the importance of understanding the simple fundamentals in order to succeed. As such, I cover a wide range of assets in order to find the best of every type of investing. Please consider following so we can continue down this path of knowledge together, and hopefully, I am able to provide some novel insights for you with every article. Thanks for reading.

Summary

Healthcare is one market no one can say is going to slow down, and so, many of the best investments lie within.
Avid Bioservices aids biotech and pharma companies in the production of CGMP level biologics for commercial therapies.
This company has been steadily improving over more than a decade, and is another buy & hold or recurring investment company I recommend.
Technician check manufacture equipment and reactors in pharmacy factory
loveguli/E+ via Getty Images
Introduction to CGMP Biologics Manufacturing

One of most important steps for a biotechnology or pharmaceutical company beyond general R&D is the wide scale manufacture of their biologics. It is of utmost concern to produce large batches of product with close to 100% purity, but in an efficient and rapid manner. One key reason for failed FDA approval or delay of approval is based on the failure to meet rigorous Current Good Manufacturing Practice (CGMP) regulations. Compliance has been an issue over the last decade or more, and so drug makers are likely to address the issue far more seriously moving forward. According to the FDA:

Adherence to the CGMP regulations assures the identity, strength, quality, and purity of drug products by requiring that manufacturers of medications adequately control manufacturing operations. This includes establishing strong quality management systems, obtaining appropriate quality raw materials, establishing robust operating procedures, detecting and investigating product quality deviations, and maintaining reliable testing laboratories. This formal system of controls at a pharmaceutical company, if adequately put into practice, helps to prevent instances of contamination, mix-ups, deviations, failures, and errors. This assures that drug products meet their quality standards.

This is where Avid Bioservices (CDMO) comes in. The company offers full life cycle services to aid clients across both the entire clinical R&D and final manufacturing cycle, an important factor for longevity of revenues. Segments include: process development, the act of optimization and innovation in efficient CGMP manufacturing; CGMP Manufacturing, including both early stage development and commercialization; analytical services, an important series of steps to determine quality and character throughout the process; and other quality control and regulatory compliance services to bring CGMP to client's locations. Typically though, most work is performed at their three Tustin, CA facilities (I like supporting my local CA companies). Further, the company is currently underway in greatly expanding capacity to support more clients, and are looking to have this complete in calendar year 2022. Management was very positive in the last earnings report and stated:

Looking ahead into fiscal 2022, we expect these expansion investments, combined with ongoing investments in the recruitment, training and retention of our workforce, to result in a continued strengthening of our core business, opening doors to new opportunities for growth. Given the expectation of increasing demand, our additional planned capacity and a strong balance sheet, we will not only be able to best support additional customers working to develop mammalian drug products, but we look forward to strategically evaluating adjacent and/or strategic business expansions that may create value for Avid and our customers.

Financial State

Fiscal year 2021 was excellent for Avid, even as the biotechnology industry saw slowdowns across the board. Most important in my eyes was the four straight quarters of positive earnings, and total net income reached $11 million over the last year. The last quarter only saw negative income due to the redemption of 10.5% series E preferreds, and the company replaced this with far more favorable 1.25% convertible senior notes. As of the last quarter, total cash has reached $169 million, far more than the $96 million in long-term debt. For investors concerned about dilution, the issuance of new shares has grown at an annual rate of 12% over the last five years, whereas revenues have increased 16.67% per year and the share price has increased 10 fold. For a stable growing company at a less than $2 billion market cap, this is quite fair in my opinion. Especially considering the new high quality, low yield debt that the company can now issue with a strengthening balance sheet.



Image 1: Source. Most recent financial release.

Looking deeper into growth rates, Avid has performed relatively well over the last decade, with an average revenue growth rate of 21.6% and increase of total assets of 17.56% per year. The only two years with difficult growth were in 2018 and 2019, with revenues remaining flat in that period, but 2020 has allowed for a jump to 60% YoY growth. Looking at each quarter individually, we can see that the cyclicality is outside of pandemic periods, and is more based on client orders with Avid. In the current low yield and innovation oriented environment, companies are willing to spend extra to outsource to a quality service provider like Avid. I expect elevated growth rates to be maintained over the next few years, then level out to 20% over the decade. With that, management expects the new capacity building to allow for up to $270 million in additional revenues, and so, if the current backlog growth of 80% YoY continues its pace, there might be a suitable long-term growth rate approaching 30% for the entire decade. I will discuss my expectations in more detail later in this article.



Image 2: Source. Recent growth has trended towards cyclicality, although 2020 shows strong elevation in revenues due to the expansion of production facilities. This is set to continue through 2022 and beyond.

It is a good sign that the company is maintaining stable positive earnings, with a net income growth rate of 25% over the past five years. This allows for safety if growth returns to the 20% mark, and one can look at the rule of 40 for support of this company. As of the last earnings, the company has a levered FCF margin of 22.5%, but look for this value to remain strong after growth subsides. However, the current 11.7% net income margin is very strong as well, so one can expect significant long-term cash flows if revenues remain strong. However, the low 30% gross profit margin indicates that a loss of revenue growth will quickly lead to reduced earnings, and having a strong client base is of utmost importance. This can be seen by the razor thin margins of AmerisourceBergen, a major competitor in the industry. At the moment, Avid looks well suited to lead the industry forward with their focus and range of capabilities in manufacturing rather than distribution.



Image 3: Source. The profitability metrics of Avid.

Since CGMP involves maintaining the newest practices for safe manufacturing, CAPEX spending is high for Avid. Typically, the company spends 7% of their revenues on CAPEX, and I believe there will be less chance for acquisitions to aid in revenue growth. This is because it is easier to expand to a new facility and deploy the novel CGMP level technology rather than purchase another company with outdated equipment. Hence, investors can feel confident in the current expansion works underway to conclude in 2022, but there will always be a part of the company being updated at any one time. Therefore, expanded capacity will allow for maintained high profit margins and then these profits will be invested back in the future revenues in-house, with an almost 30 year history of success. Fiscal year 2022 is looking to be another strong performer, as management stated: "During fiscal 2021 we signed eight new customers, and during the fourth quarter we successfully completed FDA inspections for two product approvals with zero 483 observations." Therefore, investors can feel confident in the facilities being up-to-date for the next few years.

Expectations and Conclusion

It is important to note that this is not a high growth company per se, but more oriented towards stability and earnings growth at this point. While the market cap is small, this industry is limited in size, as not many companies outsource their manufacturing inside the US. However, being the dominant individual company in this field will continue their long-term success. I believe Avid is one of those companies you can buy and toss into a recurring investment portfolio, and here is where I see the stock price going over the next five to ten years. Much of my expectations are based on a secular upward trend of increased healthcare spending, as IBB has been relatively flat over the second half of the 2010s.



Chart 1: The healthcare sector has been underperforming relative to the S&P 500 over the last five years or more, and I expect a breakout to occur soon.



Chart 2: While Avid's shares have not performed well over the decade due to the slowdown of growth starting in 2016, the trend has been moving forward strongly as financials improve. Now look for the P/E to stabilize higher this time around as the financials are expected to remain strong.

I will balance my growth expectations with the guidance put out by the company. First, the company expects a maximum of $117 million in revenues over the next year, which would account for 22% revenue growth. This is based on the current $118 million backlog, up 80% from a year prior. In this case, the revenues beat the backlog by 47% last year. While we can estimate a beat to this regard, I went back and averaged the revenue surprises over the last 15 quarters and came to a 17% average revenue beat value. This is what I will use for my bullish case. My bearish revenue growth rate will be the five-year average growth rate of 16.67%. Therefore, the possible growth rates for the next year range between 16.67% on the low end, 22% for the guidance, and 44% for the bull case. For the bull case, while 44% is a good indicator for a strong individual year, I feel that a 30% average growth rate would be better across the decade and will use this rate for long-term data. I put this data in the table below.

Growth Rate

(%)

5 Year Revenues

(Million USD)

10 Year Revenues

(Million USD)

Bear: 16.67

207.3

448.1

Guidance: 22

259.2

700.5

Bull: 30

356.1

1322

Table 1: Expected returns for each revenue growth case.

With this kind of variance across a long time period, investors can often gravitate towards one value unjustly. Each of these revenue data points are likely if utilizing historical data. Therefore, it is necessary to reduce each by their respective probabilities of outcome, and create one risk adjusted expectation. While a bear case is often not the highest probability, in this case, we can use the same earnings surprises to dictate probabilities. Over a strong period, the probability of a beat approaches 75%, but since data is limited and poor revenue years are not included, I will average down to 50%. Guidance by a company is often based on far more data than an investor could ever utilize, and so it should be a large portion as well.

In the end, I find that 50% bull, 40% guidance, and 10% bearish makes sense based on my expectations for the market and company overall. Adjust these values as you see fit, with higher bearish probability for more risk-averse investors. When calculated out, the risk adjusted five-year revenues is $302 million, and the risk adjusted 10 year revenues is $986 million. Essentially, a 26% growth rate. Doesn't that sound more reasonable to the actual probable return?

While a 26% rate of return per year sounds nice, we also have to consider the valuation of the company. Currently, the shares are richly valued at a 17x P/S, with a five-year average of 5.55. While it may seem like the price could fall down 66% to that average P/S, you have to consider that the worst financial performance of the last decade occurred during this time. Therefore, I find a more realistic value to discount to is 7.5-10. Valuation is highly dependent on outside market forces beyond the company and are hard to predict, but I think hedging to a 7.50 to 8.5 P/S makes sense for 10 years from now. That would still allow investors to see a 16.3 to 17.8 rate of return per year. This is far above the S&P historical rate of return, and has been hedged multiple times to risk potential. Not to mention, if the bullish case turns out true, the valuation will likely be unaffected long term, and that 26% per year return may be viable.

Valuation Scenario

(Price to Sales)

Average Return 5 Years

(%)

Average Return 10 Years(%)

Unchanged (17.0x)

26

26

Adjusted to 8.5x

9.5

17.79

Adjusted to 7.5x

6.76

16.32

Table 2: Potential future returns according to the newly adjusted 26% growth rate and three valuation scenarios.

Since this company has relatively stable revenues historically, but see more volatile earnings and valuation, investors would also hedge their risk by averaging their positions over time. This is why I am considering Avid Bioservices as one of the components to my sleep well at night portfolio, as the probability for above market returns is high. Although I am sure other pundits may offer more detailed formulas for discounting cash flows, etc.; I find this approach I have taken covers all necessary points to consider. If you are willing to put this stock into a portfolio and set recurring investments, you can make sure to follow my page here on Seeking Alpha to see if I update my thesis at all. Further, stay tuned for more selections soon.

Thanks for reading.

This article was written by

Another Mountain's Rock Investing profile picture.
Another Mountain's Rock Investing
702 Followers

Follow
Hello, I am an individual investor with an interest in bringing diversification of viewpoints to stock anal... more
Long-Term Horizon, Tech, Growth

Contributor Since 2020

Hello, I am an individual investor with an interest in bringing diversification of viewpoints to stock analysis and investing. This brings to point the Japanese proverb ???? -ta-zan-no-ishi- which translates to "another-mountain's-rock" and denotes the importance of diversifying the sources of your knowledge in order to gain the advantage of multiple perspectives. Further, a rock represents the foundational aspects of the world a mountain supports, signifying the importance of understanding the simple fundamentals in order to succeed. As such, I cover a wide range of assets in order to find the best of every type of investing. Please consider following so we can continue down this path of knowledge together, and hopefully, I am able to provide some novel insights for you with every article. Thanks for reading.

Disclosure: I/we have a beneficial long position in the shares of CDMO either through stock ownership, options, or other derivatives. 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.

https://seekingalpha.com/article/4448271-avid-bioservices-provides-stable-long-outlook?mail_subject=cdmo-avid-bioservices-fda-cgmp-stringency-provides-stable-long-outlook&utm_campaign=rta-stock-article&utm_content=link-2&utm_medium=email&utm_source=seeking_alpha