Martek Biosciences: Can It Turn Algae into Gold, Or at the Least Oil?

Martek Biosciences Corp. (MATK) is a global leader in the production of docosahexaenoic acid from microalgae and arachidonic acid from fungus, and as such stands to benefit from the combined U.S. demographics of an expected uptick in U.S. births, aging baby boomers and an apparently health-conscious Generation Y.

“Wait a minute! Docosahex-what? Arachid-what? Made from microalgae? Fungus? And, what does this have to do with babies, teenagers and the soon-to-be elderly?”

Docosahexaenoic acid, or DHA as its more commonly referred to, is one of the primary omega-3 fatty acids, the same omega-3s that have become all the rage as a food supplement due to their purported health benefits for the heart, brain, eyes and infant development. Arachidonic acid–ARA–is an omega-6 fatty acid that is considered an “essential fatty acid” crucial for muscle and skeletal repair and growth, and, along with DHA, considered a key component neurological development and maintenance.

The health benefits of omega-3s and in particular DHA emerged in the 1970s with a study of Greenland Eskimos who consumed large amounts of fatty seafoods, but displayed virtually no incidence of heart disease. In 2004, the U.S. Food and Drug Administration (FDA) gave DHA “qualified health claim” status that research is supportive, though not conclusive” that its consumption may “reduce the risk of coronary heart disease.”

Other studies determined that DHA and ARA were crucial in brain, eye, muscle and skeletal development in babies. Meanwhile researchers have also determined that DHA may inhibit plaque development in the brain thought to be responsible for Alzheimer’s disease, and there are indications that DHA may inhibit the growth of some cancers. Research of these health benefits and others with both DHA and ARA are ongoing, with one of the largest being a U.S. National Institutes of Health study to evaluate DHA in Alzheimer’s disease.

A primary source of DHA and other omega-3s is fish oils, and fish oil as an omega-3 and DHA dietary supplement essentially went mainstream in the late 1990s as their apparent health benefits become widely known. Fish receive their DHA intake from algae, and scientists with Martin Marietta (which merged with Lockheed (LMT) in 1995)who were researching the beneficial use of algae in long-term space flight, spun off from their parent company and developed and patented the methods for deriving DHA from algae, and ARA from a fungus.

These scientists formed Martek Biosciences in 1985, brought the company public in 1993, and introduced their first DHA and ARA infant formula in 1995 in Belgium, and received FDA clearance for its use in U.S. infant formulas in 2001.

Martek’s core product application remains DHA and ARA as a supplement in infant formulas. Sales of Martek DHA/ARA for infant formulas have more than doubled since 2003, climbing from less than $150 million in 2003 to $300 million in 2008. The company claims 99 percent penetration of the U.S. market, which it views as a “$170 million to $190 million market opportunity;” and 40 percent penetration of the international market, which it pegs as a $300 million to $325 million market opportunity, with the primary future growth driver being Asia. Martek considers consumer demand for infant formula as “stable despite the weak global economy.”

The company’s secondary product application–DHA supplements and additives for adults–has also seen robust growth, with sales climbing from about $11.5 million in 2006 to an estimated $38 million for 2009. Martek sees growing sales across all segments of this market in the years ahead, and believes there will be increasing consumer awareness about the health benefits of DHA.

The company should see increased future sales based on demographics. Although it already has all but complete penetration of the U.S. market for infant formulas, The number of women entering their key child-bearing years is set to increase by roughly 250,000 per year for the next 10 years as the large cohort of Generation Y replaces the much smaller Generation X. Along with more of them, Gen. Y is commonly believed to be much more health conscious with relation to food than members of Gen. X and the Baby Boom. This should be a boon to Martek’s sales of DHA/ARA supplements to pregnant and nursing mothers, as well as to DHA/ARA supplements for other adults.

And as the large cohort of Baby Boomers age their interest in health supplements will undoubtedly increase. The more evidence they hear supporting DHA’s health claims regarding Alzheimer’s Disease, coronary heart disease and cancer, the more money they will pour into DHA supplements, and the more likely that they will purposely purchase products (currently more than 50 and growing) containing Martek’s patented “life’sDHA.”

While the company would appear to be a two-trick pony, it recently entered into a joint development agreement with BP plc. (BP) Biofuels to produce microbial oils for use in the biofuels industry. The goal of the agreement is to “establish proof of concept for large-scale, cost effective microbial biodiesel production through fermentation.” BP committed $10 million to the initial phase of the collaboration, under which BP will own any new intellectual property developments, with Martek receiving exclusive license for application and commercialization in nutrition, cosmetic and pharmaceutical applications. While this agreement adds nothing to the bottom line in the near, or even mid, term, Martek scientists proved visionary in the past, and certainly have the wherewithal to discover new products and applications through this project.

The share price is well off its all-time high of about $67 hit in early 2005, and down about 70 percent from its 52-week high of $31.60. The share price has declined about 40 percent since early September after recording a 12 percent year-over-year decline in quarterly revenues caused by retail companies de-stocking old inventories of infant formulas. Martek executives projected strong fourth-quarter 2009 and full-year 2010 revenues, on anticipated increasing sales in both infant formula and adult products.

In our opinion, one problem with valuing Martek, is does one value the shares on a food company or a biotech company basis? Being conservative, we believe a company should be valued on its growth prospects. Martek sells on an October 2009 consensus P/E of 15.1. This falls to 13.1 on a consensus forecast for October 2010. However, the forecast for 2010 earnings per share vary enormously, with the highest being $1.80 and the lowest $1.28 and consensus of $1.40.

Therefore, we believe the shares are attractive given the revenue growth potential in its adult market products, strong cash flow, improving demographics, and the company’s stated goal of improving gross margins. We feel that the company should earn between $1.40 and $1.50 per share for the year ending October 2010.

The company is expected to report fourth 2009 quarter earnings between Dec. 11-16. Consensus estimates call for earnings per share of $0.33.

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Source: Yahoo.com

Disclosure: No Positions.

Comments

[mbkelly75:]

I looked at Martek quite a while ago and they did not fit into what I was looking for at the time. Thanks for bringing them back to my attention.
It may not be the best time to actually buy them right now as MRTK formed a Death Cross just a few days ago (21 Oct 09) @$21.63. They might be worth keeping an eye on to buy for a trade when they finish moving down and form a Golden Cross to signal they are ready to start moving up again. This would make them a better buy as right now they are just below Book Value (P/B = 0.98). Their P/S @ 1.76 and their PEG at 1.36 are both high and show that right now - they are over-valued. The drop in their price that is happening right now has a good chance of making them more attractive as a trade. Their long-term record is not very good. Holding them as a stock has consistently lost money (Over the last 5 years, - 60.90%), but they have absolutely zero debt, an outstanding Quick Ratio @ 4.35 and an equally good P/FCF at 9.15. When they form the Golden Cross - they look like an excellent trade for the ride up.

Oct 30 09:28 AM

[peterwhimsey:]

What is a golden cross?


On Oct 30 09:28 AM mbkelly75 wrote:

> I looked at Martek quite a while ago and they did not fit into what
> I was looking for at the time. Thanks for bringing them back to my
> attention.
> It may not be the best time to actually buy them right now as MRTK
> formed a Death Cross just a few days ago (21 Oct 09) @$21.63. They
> might be worth keeping an eye on to buy for a trade when they finish
> moving down and form a Golden Cross to signal they are ready to start
> moving up again. This would make them a better buy as right now they
> are just below Book Value (P/B = 0.98). Their P/S @ 1.76 and their
> PEG at 1.36 are both high and show that right now - they are over-valued.
> The drop in their price that is happening right now has a good chance
> of making them more attractive as a trade. Their long-term record
> is not very good. Holding them as a stock has consistently lost money
> (Over the last 5 years, - 60.90%), but they have absolutely zero
> debt, an outstanding Quick Ratio @ 4.35 and an equally good P/FCF
> at 9.15. When they form the Golden Cross - they look like an excellent
> trade for the ride up.

Oct 30 09:43 AM

[mbkelly75:]

Good question with a fairly easy answer. Moving Averages are used to give an easy (but effective) way to time the market. I use three (3) of them - the 20 Day, the 50 Day and the 200 Day. When the 20 Day moves through the 200 Day moving DOWN - that is a Death Cross and shows that the market is trending down. When the 20 Day moves through the 200 Day moving UP - that is a Golden Cross and shows the market is trending up. Good profits can be made by selling when a Death Cross forms and/or buying when a Golden Cross forms. The 50 Day MA is simply used to help you see times when you need to pay more attention when the 20 Day is on it's way to form one or the other Cross.


On Oct 30 09:43 AM peterwhimsey wrote:

> What is a golden cross?

Oct 30 08:19 PM

[mbkelly75:]

One more thing, I use a program called "Market Browser" that makes following the Moving Averages and seeing both the general trends and finding the Crosses MUCH easier.

Oct 30 08:31 PM