Santarus (SNTS) has corrected as much as 25% since reporting earnings in early August. The selloff is a consequence of post-earnings profit-taking and an analyst downgrade on August 22. I believe that the stock has likely bottomed, and that this correction presents a compelling buying opportunity, given the company's strong growth prospects, and attractive forward valuation. The following attributes make this stock an appealing investment opportunity, with at least 30% short-term upside potential, and long-term potential for triple digit gains:
- A solid product portfolio, consisting of five products, and three more products in the pipeline (two of them being in late-stage development). The company is also making efforts to expand indications for the already marketed drugs.
- Conservative management guidance and conservative analyst estimates. I believe that the future growth is underestimated by both management and sell-side analysts. Management has been raising revenue and profit estimates in the past several quarters. Analysts are following suit, but they have massively underestimated their estimates in the past, as evidenced by the earnings surprises in previous quarters.
- The stock is trading at a significant discount to growth, and a low forward valuation. Santarus is currently trading at a forward P/E of 10.8, a very low multiple, considering the expected growth rates. On an ex-cash basis, the valuation seems even more compelling.
- Potential acquisitions are not reflected in the share price. Management declared in the Q1 conference call that they are aiming to acquire smaller companies, which might further expand their product portfolio.
Santarus currently has five marketed products:
1. UCERIS™ (budesonide) extended release tablets for the induction of remission in patients with active, mild to moderate ulcerative colitis. The drug was launched in February 2013, and its revenue in the second quarter was $16.2 million. The company expects peak sales around $300 million.
2. ZEGERID® (omeprazole/sodium bicarbonate) for the treatment of certain upper gastrointestinal disorders is promoted to gastroenterologists. Zegerid's Q2 revenue more than doubled to $21.6 million from $10.3 million in Q2 2012.
3. GLUMETZA® (metformin hydrochloride extended release tablets). Glumetza revenue increased 39% to $44.4 million in the second quarter.
4. CYCLOSET® (bromocriptine mesylate) tablets, which are indicated as adjuncts to diet and exercise to improve glycemic control in adults with type 2 diabetes. Cycloset brought $4.3 million in Q2, a 115% year-over-year increase.
5. FENOGLIDE® (fenofibrate) tablets, which are indicated as an adjunct to diet to reduce high cholesterol, are promoted to endocrinologists and other physicians who treat patients with type 2 diabetes. Fenoglide was the only product which had a drop in revenue, from $2.1 million in Q2 2012 to $2 million in the latest quarter.
Santarus' product development pipeline includes:
1. Investigational drug RUCONEST® (recombinant human C1 esterase inhibitor). A BLA for RUCONEST was submitted to the FDA in April 2013 for the treatment of acute angioedema attacks in patients with HAE.
2. Rifamycin SV MMX®, which is in Phase III clinical testing for treatment of travelers' diarrhea.
3. Santarus has completed a Phase I clinical program with SAN-300, an investigational monoclonal antibody.
Management estimates peak sales for the marketed product portfolio between $650 million and $750 million. The two late stage products Ruconest and Ryfamicin are expected to reach $200 million peak sales for initial indications.
Santarus also plans to start two clinical studies in 2014 to expand the indication for Uceris. The first is the pediatric phase 3 study for microscopic colitis, which affects around 50,000 patients in the U.S. which qualifies for orphan drug status indication. The second one is focused on treatment of microscopic colitis, which affects about 300,000 to 350,000 patients in the U.S. These two indications could bring between $170 million and $270 million in additional revenue from Uceris.
With current marketed products and the robust pipeline, Santarus could easily reach $1 billion revenue in the next few years.
Conservative management and analysts
Santarus management has proved to be very conservative with FY 2013 guidance. In the Q4 2012 they guided for revenue between $320 million and $325 million and adjusted EPS between $0.92 and $1.00. In the next two quarters, they raised revenue guidance to a range of $330 million to $340 million in the first quarter and to a range of $355 million to $360 million in the second quarter report. Consequently, earnings expectations were raised to $1.03 to $1.15 range in the first quarter and to a range of $1.21 to $1.26 in the second quarter. Given these numbers, adjusted profit margin guidance was 23.5% in Q4 2012, 25.7% in Q1 2013 and 27.7% in Q2 2013. This shows that management aims to under-promise and over-deliver.
Analysts have been conservative too. Their FY 2013 earnings consensus estimates are on top of the management guidance at $1.26, while they expect revenue to be $2 million above management high-end guidance. And these estimates have been raised aggressively in the past 90 days. I believe that the estimates have not been raised enough, especially when you take management conservatism into account. Earnings surprises in the last four quarters reveal that both management and analyst estimates were in fact quite conservative, since Santarus beat earnings estimates between 30% and 700% in the past four quarters.
I also suspect that the FY 2014 and 5-year growth rates are also largely underestimated. Analysts seem to neglect the strong product pipeline, and potential new indications for Uceris that might boost the expected peak sales to a level that is double to company's TTM revenue. The 5-year expected profit growth rate stands at 10% and seems as a misprint, given this year's and next year's expected growth rates (366% and 66% respectively).
Deep discount to growth
Santarus is currently trading at a deep discount to growth. The company's trailing adjusted P/E is 26.9, while the forward P/E is as low as 10.9. Santarus' expected profit growth rate for FY 2013 is 366% and 66% for FY 2014. If you take the 2014 growth rate, you get a PEG ratio of 0.42. And you will rarely see a growth stock with these numbers trading at a forward P/E of 10.9. On an ex-cash basis, the stock is trading at a forward P/E of 9.8. I expect this mispricing to be corrected by year-end, and I believe that the stock has at least 30% upside to achieve the forward P/E of 15, which is highly conservative given the growth prospects. Santarus also presents a long-term growth opportunity and can easily double or even triple if everything goes as planned by the highly conservative company management.
Acquisitions - a potential surprise catalyst
The company announced earlier this year that it plans to add one additional senior executive position focused on strategic planning and acquisitions. The company will start to look for smaller companies that would allow Santarus to extend in areas such as gastroenterology, endocrinology and other selected specialties.
Another thing the company is exploring is geographic expansion. The management will continue analyzing the potential of international expansion in next one to two years.
Acquisitions and potential geographic expansion will broaden the base for revenue and earnings growth in the following years. The company has a strong balance sheet, with $152 million in cash and equivalents, and almost no debt ($9.9 million long-term debt).
Risks and challenges
The biggest risk for the company is the loss of Glumetza and Zegerid patents in 2016. Expanding sales of Uceris and potential new indications and a promising pipeline should be enough to bridge the revenue gap that will evolve beyond 2016. And potential acquisitions could bring an expansion of marketed products and broaden the existing pipeline.
Santarus is a very successful biotech with a strong portfolio of marketed products and a promising pipeline. I have a $30 price target, based on a forward P/E of 15. Long-term profit potential is likely north of 100%. There are several catalysts that will drive the share price higher:
1. Third quarter earnings report. Management guidance and analyst estimates are conservative, and the company should easily beat estimates. The expectations might be lower since Wall Street has taken into account the Leerink Swann downgrade in late August. Analyst Jason Gerberry lowered his PT to $26 (which is 15% higher than the current share price) on his survey of gastroenterologists, which suggested that Uceris sales will not exceed current consensus estimates. Other analysts remain positive, and Santarus has four buy ratings and one hold, with a mean PT of $28.40 (26% above the current price). Management should further raise FY 2013 guidance, as it did in the previous quarterly reports.
2. Pipeline developments. Santarus has two late-stage candidates that will likely receive approval in the next twelve to eighteen months. Additional indications for already marketed products serve as another potential catalyst.
3. Acquisitions - the company is likely to make acquisitions in the near future, which might further expand its marketed product portfolio and development pipeline.