Chembio Diagnostics Inc. (NASDAQ:CEMI) is an undervalued biotechnology company that has a revolutionary patented Dual Path Platform (DPP) Technology in its arsenal and will continue to use this asset to generate growth in the future. Currently, the stock is trading near the $4.60 mark with a market capitalization of $42.22 million, but maintains a TTM P/E of 6.45. In comparison with the Health Diagnostic Industry's aggregate average P/E of 104.2, CEMI is a value stock that should be taken advantage of.
Chembio Diagnostics is a New York based company that designs non-invasive, rapid point of care diagnostic tests for various diseases including four tests for HIV, two for syphilis, and one for canine leishmaniasis. The company is also developing tests for influenza and Hepatitis C. Three of the HIV tests are blood dependent tests designed using in-licensed and proprietary lateral flow technologies from Alere Inc., and are manufactured in cassette, dipstick, and a barrel format. Lateral flow technology is seen in many home pregnancy tests for those that are interested in putting an image to these diagnostic tools. The barrel and cassette formats are proprietary and exclusively distributed by Alere within the United States and by Chembio outside the United States. Since April 2006, Chembio has entered an exclusive 10 year agreement with Alere to market the FDA approved versions of the HIV Antibodies 1/2 test in the United States under the Alere brand name. Additionally, Chembio has sought out international distributors for the lateral flow HIV diagnostic tests in Africa, Asia, South America, and Mexico. Along with the HIV tests, Chembio also reaps in revenue from sale of syphilis and canine leishmaniasis rapid point of care tests. In FY2013, lateral flow test sales generated $13.5 million in revenue, a 4.98% increase from FY 2011.
DualPath Platform (DPP) Proprietary Technology:
In 2007, Chembio patented the Dual Path Platform (DPP) technology that has shown to be superior than competing diagnostic technologies such as the lateral flow technology. One significant potential for this technology is "multiplexing" which allows for the adoption of a test that detects biomarkers for more than one infectious disease. DPP also maintains various edges on the lateral flow technology by its increased sensitivity, especially during the screening of more challenging sample types such as saliva instead of blood. Experimental results demonstrate that DPP technologies are 10 to 50 times more sensitive than lateral flow depending on the disease and sample type. FDA approved label claims, based off of FDA approved clinical trials, show that the sensitivity/specificity on oral and finger stick blood fluid are 98.9%/99.9% and 99.9%/100% respectively. Oral fluid sensitivity increased to 100% amongst HIV-positive adults not currently taking anti-retroviral drugs (which would be the majority of the patients who would benefit from this diagnostic tool). Additionally, the DPP test is effective in detecting the HIV 1 and 2 antibodies in patients two years of age and older.
On December 21, 2012, the company announced that the FDA had approved the DPP HIV test and the stock jumped over 25%. The company expects to complete testing and the application process for a CLIA waiver (these are given to tests that have been approved by the FDA for home use) to launch the product in the US by the latter half of 2013.
In 2011, the HIV, Leishmaniasis, Leptospirosis, and Syphyilis DPP based diagnostic tests became approved by the health regulatory agencies in Brazil, and Chembio subsequently began marketing and selling its products with the Oswaldo Cruz Foundation in Brazil. In 2011, Chembio shipped DPP products worth $4.3 million and in2012 that number increased 137% to $10.1 million.
Currently, 1.2 million adults in the United States are infected with HIV with 20% of that crowd not even realizing that they have been infected, leading to an excellent window of opportunity for Chembio to take significant market position with the DPP technology tests. According to a rough calculation done by the company, an average of $8.00 per test would yield a $120-150 million dollar market in the US alone. Unless HIV becomes eradicated through a virus or a miraculous public health endeavor, the HIV testing market will be gold. With no competitor to the lateral flow technology with equal sophistication and success as the DPP technology, I am betting that Chembio would take at least 25% of the US market share, or at least $30 million from just the US HIV market. In conjunction with the sale of these same test in foreign markets and tests for other infectious diseases, the growth potential for Chembio is much undervalued with its current 6.45 P/E.
Chembio has seen profitability since 2009 with revenue growing consistently year over year, but due to research costs, administrative expenses, and deferred tax assets net income in 2012 decreased from the year before. Product sales of the lateral flow products as well as the approved DPP tests in Brazil have seen strong growth year over year. In 2012 net product sales increased by 39.63% from $17.4 million to $24.327 million, but what is even more encouraging is that DPP product sales in Brazil increased by 137% from $4.3 million to $10 million. The increase was due to higher demand from Brazil's health organizations, and this enthusiasm for the DPP products is a preview of the potential success of these same products in the United States. Product sale gross margins have decreased by 354 bp to 39.08% due to higher commission fees for DPP sales in Brazil and license/royalty fees for the lateral flow products. Once Chembio begins to market and sell DPP products in the United States, I expect gross product margins to increase as overall selling expenses will decrease.
On May 9th, Chembio will report Q1 2013 earnings, and I expect the numbers released to be a positive surprise based on evidence from current inventory assets and accounts payable.
Fixed Assets, Net of Depreciation
The data shows an increase in inventories and accounts payable (purchases made by the company on credit to finance its operations) year over year, and these short term investments imply that the company expects sustained or higher demand in the near future. Taking verbatim from the company 10-k, "The increase in accounts payable and in inventories were both primarily due to a larger amount of materials ordered and manufactured for orders due to ship in the first quarter of 2013." Consensus estimates are at $.02/share or approximately $190, 000 in net earnings using a diluted 9.29 million share count.
Cost of Goods Sold (CoGS)
Income Before Taxes
If we assume that the company maintains inventories more or less at the level recorded at year end, we can calculate the inventory turnover rate to be (CoGS/Inventories) about 6, which means that inventory is cleared every 60 days or approximately 2 months. Thus, for the 3 months in Q1 2013, we can assume that inventories will be cleared 1.5 times, and since business partners, major customers, and regulator environments did not change drastically this past quarter, we can extrapolate from the most recent revenue and earnings numbers. In 2012, for every dollar of Inventory (or CoGS), the company yielded $.10 of earnings before taxes. Assuming that Chembio will sell inventory 1.5 times (which the company has planned to do), the company will sell $3.7 million worth of inventory, which translates into approximately $373, 000 worth of earnings before tax. Using a 35% corporate tax rate (which is higher than what it will actually be with deferred tax assets), Chembio will still earn $243,000 in net income, or around $.03 per share. Note- these estimates are made using highly conservative numbers and the highest tax scenario possible.
There is risk in investing in a company that has active competitors, and in this case, companies such as OraSure and OraQuick also make directly competing HIV testing products. Even if these products do not completely sequester the infectious disease market share, the competition may force Chembio to reduce prices and subsequently reduce profitability. Furthermore, there is still significant financing that needs to be accomplished in order for Chembio to scale its operations and become the OEM for its diagnostic tools (both lateral flow and DPP). To fund the long term capital and short term raw materials, consistent cash flow must be generated or borrowed through competitive financing. Lastly, the HIV disease may one day be eradicated by an ingenious vaccine or miraculous public health campaigns, and such a momentous event will save many lives but will severely undercut Chembio's profitability. Luckily, the company is undergoing active research and pursuing approval for tests for various disease besides HIV, but not limited to Influenza, Syphilis, leishmaniasis, and Hepatitis C.
Chembio is a front runner in the diagnostic testing industry with its patented DPP technology, and that edge will continue to exist for the next 14 years. Starting in the latter half of this year, Chembio will see significantly stronger earnings as the DPP HIV test should receive a CLIA waiver by then, and the sales seen in Brazil will be mimicked if not improved upon here in the United States. Furthermore, with a Total Assets to Total Debt ratio of 133 and only $80, 000 of long term debt, Chembio has placed itself in a healthy financial position to finance its future earnings.