Sorting the Wheat from the Chaff

As seen in this month’s Master Investor Magazine

Clinigen (CLIN)

Clinigen supplies drugs for clinical trials, many of which compare an experimental treatment with one already on the market. It also supplies unlicensed medicines into markets where a drug is being withdrawn or where there is no alternative. In addition to this, it also buys drugs from other companies, such as AstraZeneca, which sold it the anti-viral agent Foscavir in 2010.

The Clinigen Group was formed in 2010 and comprises two divisions – Services and Products. The group manages the supply of drugs into a total of 53 countries, with particular expertise in the therapeutic areas of leukaemia (and other areas of oncology), haematology, transplantation, anti-infective, pain management, gastrointestinal and hospital and critical care, as well as orphan diseases.

Clinigen offers investors exposure to a very attractive and potentially highly lucrative business model. Through its extensive network of relationships with major pharmaceuticals firms, Clinigen’s specialist Services division offers the perfect forum for the firm’s M&A drive to grow its Specialty Pharmaceuticals business, which is looking to replicate the success of peers such as Alliance Pharma, but on a global scale. This is not your typical pharmaceuticals company funnelling money into drug development programmes that may or may not succeed; Clinigen is able to cherry pick tried and tested drugs where it sees an opportunity to exploit its own infrastructure and expertise, thereby making it a lower risk play than many of its peers.

The Clinigen investment case fits well into the current trends taking place in the pharmaceuticals market. Firstly, under pressure from tightening regulatory requirements and falling returns from R&D, large pharmaceuticals firms are increasingly turning to outsourcing as a means to simplify and streamline their businesses. Clinigen’s expertise lies in helping pharmaceuticals companies navigate these regulatory and logistical hurdles, which become particularly complex when the drugs are unregulated (but required by a critically-ill patient). Meanwhile, the firm’s commercial relationships with pharmaceuticals firms (it currently works with 15 of the top 20 pharmaceutical companies) also bring added benefits in that it is kept alert to any potential acquisitions for its Specialty Pharmaceuticals arm.

When some pharmaceuticals products approach the end of their life cycle they can become non-core to a firm’s strategy and a drain on resources. Clinigen offers pharmaceuticals firms an exit route, either via management through its GAP business (enabling access to patients reliant on the drug even as sales, marketing and direct distribution is terminated by the pharma company), or through the outright acquisition of the drug by Clinigen Products. Although such drugs may no longer fit with a particular pharmaceutical company’s strategy, it does not follow that they are a bad investment for Clinigen: since its acquisition from AstraZeneca in 2010, Foscavir has delivered a four-fold growth in sales under Clinigen’s management.

In April Clinigen announced what appears to be a potentially transformational acquisition. In a £225 million deal, Clinigen acquired Idis, the global market leader in providing access to unlicensed medicines in over 100 countries, across several therapeutic areas (including oncology, immunology and orphan indications). Although pricey (Clinigen had to pay c.14x EBITDA), the deal offers some compelling synergies, with Idis strengthening its offering in all three of its main divisions. It also brings Clinigen one big step closer to reaching its goal of becoming the go-to provider of unlicensed medicines – a market which, according to joint house broker Peel Hunt, currently amounts to $2.2 billion, with the potential to grow to >$5 billion. Peel Hunt forecasts earnings growth of more than 26% in FY16, and its current target price for the stock is £10.

Tristel (TSTL)

Hospital-acquired infections (HAIs) are new infections that patients acquire as a result of healthcare interventions to treat other conditions. Although some high-income countries have national surveillance systems for HAIs, there is less data available from low- and middle-income countries. However, recent systematic reviews have estimated hospital-wide prevalence of HAIs in high-income countries at 7.6%, and in low- and middle-income countries at 10.1%. This is a sizeable and growing problem for healthcare organisations worldwide. HAIs result in prolonged hospital stays, long-term disability, increased resistance of micro-organisms to antimicrobials, massive additional costs for health systems, high costs for patients and their families, and unnecessary deaths. According to the World Economic Forum’s 2013 Global Risks Report, superbugs kill 100,000 Americans, 80,000 Chinese and 25,000 Europeans annually. The UK’s Chief Medical Officer, Dame Sally Davies, describes the threat from these “nightmare” antibiotic-resistant diseases as nothing short of “apocalyptic”.

Enter Tristel (TSTL). Based out of its manufacturing base in Cambridgeshire, the company develops proprietary infection, hygiene and contamination control products used by organisations in healthcare, pharma, personal care, and animal care. Its patented chlorine dioxide chemistry is clinically proven and deployed in more than 400 UK hospitals. With 96% of its business derived from high-margin consumables (i.e. non-discretionary everyday items), Tristel has strong forward visibility and is therefore a highly profitable business. This also has great benefits for healthcare providers, as it helps reduce capital and operational spend at the same time as raising hygiene standards. Furthermore, more than 70% of sales come from proprietary products, meaning that the bulk of Tristel’s business is conducted on the back of its own internally generated technology.

Tristel has created a unique position in high level instrument disinfection in the ambulatory care market as well as sporicidical surface disinfection in hospitals by focusing on chlorine dioxide. Revenues from its instrument disinfectants for ambulatory care have grown at a CAGR (compound annual growth rate) of 49% between 2005 and 2014; and revenues from its sporicidal surface disinfectants have grown at a CAGR of 72% between their first launch in 2007 and 2014. It also anticipates entry into new product segments in the near future. Specifically, the company is said to be looking at airway management (anaesthesia), skin, military medicine, pre-hospital, humanitarian aid and ophthalmology. Furthermore, its chlorine dioxide chemistry benefits from strong intellectual property protection as well as know-how. Patent lives extend up to 2031 and firm continues to invest in a constant stream of new patent applications which are related to both new concepts as well as extensions of existing products. The firm now holds almost 100 patents, and 72% of revenues are now derived from products with IP protection. All this means that barriers to entry are high, and once embedded in hospital routine and best practice, Tristel products are hard to dislodge.

Despite a negative impact from geopolitical issues in Russia and forex headwinds from a relatively strong pound, Tristel reported that both revenues and profit were ahead of budget in a trading update for the 10 months to April 2015. The firm now expects full year adjusted pre-tax profits to be at least £2.5 million, up from £1.8 million in FY14. Management’s stated goal is to lift turnover (organically) by at least 50% over the next three years from the FY14 base line of £13.5 million – a move which would entail pushing pre-tax profit margins above 15%. Research house Equity Development sees further earnings growth of 20.5% in FY16 and 19.7% in FY17. Tristel also boasts a clean balance sheet and net cash position of over £2 million, which presumably leaves the company well placed to carry out bolt-on acquisitions should any suitable opportunities arise.

Sprue Aegis (SPRU)

Founded in Coventry in 1998 and listing on the old OFEX market back in 2001, Sprue Aegis has grown over the years to become a leading supplier of home safety products and manufactures one of the world’s smallest carbon monoxide sensors for use in carbon monoxide alarms. Products are designed in-house, with the majority of manufacturing being outsourced to contractors in China. From its initial product, the Fire Angel smoke alarm, which fits into a standard ceiling mounted light fitting, the company has built up a strong presence in the UK retail and trade market, as a supplier to the UK Fire & Rescue Services, and has also made significant progress in Continental Europe. Sprue’s status as sole supplier to a number of major retailers in the UK provides significant barriers to entry, as do its 68 granted patents, further 27 patents pending globally and safety certifications for its products from various regulatory bodies.

FY14 saw adjusted operating profit almost double to £10.4 million, mainly on the back of positive legislative tailwind in Europe, France in particular. This came on the back of a record sales performance with revenue up 36% to £65.6 million, and notably group profit would have been approximately £1.7 million higher than reported had exchange rates remained at last year’s level. Profits were well backed by cash flow, with £8.8 million net cash generated from operations, leaving the net cash position at a reassuring £15.9 million at period end. This also enabled a continuation of the strongly progressive dividend policy, with the total payout of 8p for the year representing a 33% increase on FY13.

Sprue increased its spending on product development to £1.8 million during the period, from £1.4 million in FY13, underlining its commitment to innovation. In December 2014 Sprue launched a new and upgraded UK trade range with cutting-edge value-added features which are intended to increase its relatively low market presence in the trade sector. Also on the cards is a connected home product solution using a cloud-based technology platform, which will allow remote monitoring of alarms – if your house is on fire, you want to know about it, right?! In addition it is gradually installing its miniaturised carbon monoxide (CO) sensor, the Nano-905, into its CO detectors during 2015, which is yet another feature to help differentiate its products from the competition.

However, one major factor has taken a bit of steam out of the shares of late. With a significant amount of sales being generated in Europe, the weakening of the euro against the pound is set to have a negative impact in FY15. Although house broker Westhouse expects revenues to grow from £65.9 million to £74.9 million in FY15, profit before tax is expected to come in £0.2 million lower at £10.2 million. Forecasts have also been downgraded for FY16, when profit before tax is expected to fall to £9.2 million, “purely due to the weaker euro”, before rising to an estimated £12.4 million in FY17. However, it should be noted that any strengthening of the euro would be likely to lead to forecast upgrades. In any case, Westhouse’s 400p price target offers significant upside to the current share price, and there is also a >3% dividend yield for the meantime. Given the short-term nature of currency headwinds, the recent setback for the share price could prove a useful buying opportunity.