Investments In Society's Sweet Tooth: Old and New Ideas

Includes: JNJ, KO, PEP, SNMX, STVF
by: Henry Kawabe

Vivus' (NASDAQ:VVUS) and Arena's (NASDAQ:ARNA) approvals of their respective obesity drugs were huge catalysts for investors willing to endure the risks associated with possible FDA rejection or delay. The headlines for these two companies were frontline in many healthcare, pharmaceutical, and investment publications, and illustrated two key points. First, there is a huge area of need with society's changing lifestyle in the U.S. and abroad to help individuals to lose weight and maintain these losses. Secondly, as illustrated above, this area of need can be utilized for investment gains if proper entries and exits are utilized. One of the biggest contributing factors to the obesity epidemic that Vivus' and Arena's drugs hope to address is consumption of calories, which, combined with our more sedentary lifestyle, has largely contributed to the problem. The use of sugar and high fructose corn syrup in society's diet in everything from soft drinks and snacks to desserts is a large part of the caloric intake of Americans. This consumption is evident in the fact that Americans, on average, consume 150 pounds of sugar annually. With 4 calories per gram of sugar as the generally-accepted rule of thumb, this equates to about 272,400 calories per year consumed by the average American from sugar intake alone.

Although not likely to have the gains exhibited by VVUS and ARNA, there are three publicly-traded companies that have been, or soon will be, attempting to capitalize on society's realization of its need to reduce calorie consumption due to its growing obesity problem, and to also capitalize on the necessary reduction of sugar intake for diabetic patients. The companies presented offer a diverse level of market capitalizations, financial stability, M&A potential, upside potential, and downside risk. Investors should carefully consider their risk tolerance as they review each of these company's financials, current and potential marketed products, and any other criteria to ascertain their risk assessment.

The "Old" - Aspartame's Lucrative Market Being Chipped Away, But Major Supplier Still Has a Bullish Chart

Ajinomoto Company, Inc (AJINY.PK) is currently the world's largest supplier of the controversial artificial sweetener, aspartame. Discovered by accident in 1965 by a researcher at drug manufacturer, G.D. Searle, the FDA approved the additive for use in dry foods in 1974. However, amid criticism for Searle's studies it had performed to confirm the safety of the additive, the approval was revoked in December of 1975. After much debate and criticism that continues even to this day, Searle was again allowed to continue manufacturing and marketing aspartame in dry foods in 1981. In 1983, the use was broadened to include approval for use in carbonated beverages, now a multi-billion dollar industry for the soft drink manufacturers. Final restrictions on aspartame's uses were removed in 1999, which allowed it to be used freely in all foods.

A product of a coupling reaction between the amino acids L-phenylalanine and L-Aspartic acid, aspartame is approximately 200 times sweeter than sugar (sucrose). Having only about 4 calories per gram, the low levels of aspartame required to comparably sweeten a food or beverage is very low and imparts very few calories. The sweetener does have its drawbacks, with the first being its sensitivity to decomposition under high heat conditions, which essentially excludes it from recipes requiring baking; but, it can be used in low-calorie icing, jellos, pudding, and other products prepared under moderate heat or ambient temperature conditions. Particularly disconcerting is a breakdown product of aspartame under high-heat conditions, diketopiperazine [DKP], a known or suspect carcinogen (depending on the source). Regardless of one's interpretation of the carcinogenicity of DKP, the breakdown product is bitter and has an unpleasant taste.

Despite its controversial history and increasing presence on the internet by self-proclaimed experts touting all of its evils, aspartame still has a huge presence in the artificial sweetener realm and has a dedicated fan base in many diet drinks. For example, experts and consumers agree that Diet Coke tastes almost nothing like "regular" Coke. However, the unique flavor of Diet Coke, after-taste and all, allowed it to pass regular Pepsi in 2010 for the number 2 spot in total soft drink sales in the U.S., with 927 million cases of the diet drink sold, second only to regular Coke's 1.6 billion cases. However, Ajinomoto's dominance in the artificial sweetener market has not gone unrivaled. It has been fighting saccharin's presence for years now and has been facing a bigger threat in sucralose, marketed under the trade name Splenda®, which was approved as a tabletop sweetener in 1998 and as a general purpose sweetener in 1999. Manufactured by Johnson & Johnson's (NYSE:JNJ) McNeil Specialty Products Company, sucralose is a modified sugar compound. Three hydroxyl groups on the sugar molecule are replaced with chlorines yielding a compound that is 600 times sweeter than sugar and is stable enough to be utilized as a full-sugar replacement for baking, tabletop use or anywhere else sugar is used. The hydroxyl group displacement by chlorine also makes the compound impossible to biologically metabolize, yielding a true zero calorie additive.

Although still maintaining a dominant presence in the low-calorie sweetener market place, continued negative publicity and competition have been taking a toll on sales of aspartame with the product now being ranked number three in 2012 low-calorie sweetener sales, with Splenda® and stevia taking over as numbers 1 and 2, respectively. In its 1H 2012 financials, Ajinomoto stated:

Sales of low-calorie sweeteners for home use and the restaurant market were the same level as the previous interim period. Sales of powdered juice Refresco MID®, which contains aspartame, in South America grew steadily, but sales of aspartame, a sweetener, for the processing industry decreased considerably, impacted by a decline in sales volumes as well as foreign exchange rates, and as a result sales decreased overall.

Ajinomoto's presence in the low-calorie sweetener field gives it a great deal of exposure for those wishing to capitalize on the need for calorie reduction worldwide. A likely secure investment despite decreasing aspartame sales, the $9.7 billion company also pays a dividend to shareholders of about 1.5% annually. Climbing steadily since 2009's sub $70 price per share, the company is now trading at its 52-week high on a bullish trend increasing roughly 24% annually, a phenomenal accomplishment for a multi-billion dollar company.

The "New" - Stevia Plant Extract Taking Sweetener World by Storm, a Bio-Agri Investment Possibility

A rising star in the United States, stevia plant extracts have been used in some countries for decades and even centuries. However, it has just recently started gaining wide-spread attention as safety concerns over many of the artificial sweeteners keep resurfacing. Japan's early concerns over the artificial sweeteners prompted the country to approve stevia's use in the early 1970s with commercial production beginning in 1971. The rest of the world has been slow to accept the plant's extracts as a sweetener, with the U.S. finally allowing sales of one of the plant's extracts, rebaudioside A, as a food additive in 2008, and the EU following suit in December of 2011. Rebaudioside A (CAS no. 58543-16-1 for the scientifically inclined) is one of the four major steviol glucosides found in stevia's leaf tissues that contribute to its sweet taste. It is the sweetest component at 350-450 times sweeter than sugar, and is thought to have the least bitter aftertaste. Marketed predominantly in the U.S. as Truvia® from a joint partnership with Cargill and The Coca-Cola Company (NYSE:KO), and Purevia® through a partnership of Pepsi (NYSE:PEP) and Whole Earth Sweetener Company, the combination of the two sweeteners have eaten market share away from sucralose (Splenda®), aspartame (Equal®), and saccharin (Sweet N'Low®). According to a January article in the WSJ, Truvia® is now a dominant branded sugar substitute, second only to Splenda® in sales.

With very few concerns over the natural sweetener's safety, many complain of a bitter aftertaste or a licorice-like flavor depending on what it's used to sweeten. However, current sales seem to indicate that the "natural extract" selling point is the over-riding factor. One should also consider the fact that the sweetener does not necessarily have to taste exactly like sugar, as the Diet Coke sales example above indicates, in order to be successful. This, combined with society's need and desire for a low or zero calorie sweetener, will likely only fuel the additive's growth.

With stevia's growth and popularity, investors will likely attempt to capitalize on the growth potential in this budding sector that will be targeting both weight-loss markets (like the block-buster drugs recently approved and soon to be marketed by Arena and Vivus) and diabetes, two mega-potential markets giving solid upside potential for the right investment choice. A small upstart company located in California's Central Valley, Stevia First Corporation (OTCQB:STVF), appears to be a possible investment candidate to take into consideration for exposure to the growth explosion now taking place in stevia. Having a unique growth strategy to capitalize on the growth in the sector, Stevia First appears to be focusing not on the refined product sales and the costs associated with such manufacturing and marketing, but rather on supplying its customer base with a cost-effective, consistent, and steady supply of stevia leaves.

Being a natural product, a simplified supply of a consistent composition is not easily achieved and will be a huge competitive advantage if done so successfully. In ideal circumstances, the manufacturers would receive a consistent and potent product which would allow their extraction, purification, and concentration processes to operate smoothly without having to perform a huge number of laboratory analyses to constantly have to modify manufacturing parameters in order to compensate for varying levels of active ingredients (Rebaudioside A in this case) in many natural products. Stevia First intends on operating as an agri-bio business model that hopes to take advantage of the local supply of "a rich talent pool of farmers, agronomists, agricultural innovators, and equipment suppliers in California's Central Valley, biotech expertise from neighboring universities, and access to U.S. Government funding" in order to prosper its research, development, and sales of quality stevia plant leaves.

In its latest 10Q, the company indicated it had total assets of $1.14 million with $917 thousand of that in cash. The current high ratio of cash to total assets is a result of a combination of financing and the fact that the company is currently leasing the land to be utilized for growing the stevia crops (1,000 acres in Sutter County, CA). Additional office space and laboratory space is also being leased in Yuba City, CA. Until the business model begins to more fully unfold, the leasing arrangements limit the company's risks of long-term obligations until it begins marketing its product. From an investor perspective, the company's common stock is currently trading at its 52-week low with a 52-week range of 0.25 to 3.28. Given the right news of successfully planting and cultivating its product along with a sales agreement of some sort, the upside potential here is indeed significant. Any intellectual property protection or developments indicating a novel and promising plant extract giving it a competitive edge over its stevia competitors would also be a potential share-price moving catalyst.

The company is a development-phase entity with risks inherent, including bankruptcy or at least significant dilution due to offerings if the right financial arrangements aren't made and if the company doesn't start generating revenue in the near future; so this is a speculative and risky investment for consideration. The company hinted at near-term goals in its 2Q financials stating:

Over the 12 months following the date of this report, we expect to continue to review potential acquisitions and alliances including the purchase of rights to additional land that is suitable for stevia cultivation, and to complete the build-out of a stevia tissue culture laboratory and nursery in California. Total expenditures over the next 12 months are expected to be approximately $1,000,000. After giving effect to the funds raised in the January Private Placement and the February Subscription Agreement, as of the date of this report we expect to have sufficient funds to operate our business for at least 12 months.

If all goes as planned, the downside risk could be muted somewhat with positive news in the coming months. However, delays and/or unforeseen setbacks could be devastating for the company's dwindling share price, so this is not an investment for those with low risk tolerance.

The Novel - Making Optimal Use of Current Sweeteners

Senomyx, Inc. (NASDAQ:SNMX) has been flying under the radar for most investors in the sector. The company is taking a novel approach to calorie reduction with its growing portfolio of taste modifiers. Rather than trying to replace sugar, high fructose corn syrup [HFCS] or even sucralose, the company has a growing base of 339 patents with many others outstanding protecting its novel platform of taste modifiers. These modifiers increase the consumer's taste sensitivity for the targeted sweeteners in such a manner as to allow them to utilize much less of select sweeteners in order to have the same perceived level of sweetness. The company has a diverse program of flavor modifiers with five products being applicable to the current subject matter. The market potential for each of these could be substantial when/if they hit mainstream as the focus is on the most commonly-used sweeteners in the world. Not only could these products reduce caloric intake due to the lesser amounts of sweeteners required, but manufacturers would also benefit from having to use less of the expensive sweeteners in their products.

Senomyx's S6973 and S6932 sucrose modifiers could potentially be its biggest products for direct sales, licensing or acquisition purposes. The two modifiers allow up to a 50% reduction in sucrose in order to have the same perceived level of sweetness as their non-additive counterparts. With success in many beverages and foods, the upside here could be substantial if food or drink manufacturers begin to show real interest in the products. S52617 (S-617) also has a lot of potential with what is termed:

a very meaningful reduction of both HFCS and sucrose in taste tests with product prototypes.

With the high level of HFCS used in today's soft drinks, proven success with S-617 could be a huge catalyst for this $75 million company. A fourth flavor modifier termed "S2383" has an interesting application as it improves the potency of sucralose (already about 600 times sweeter than sucrose) and enables a 75% reduction in the amount of the expensive sweetener utilized. Applicable to stevia, which some claim can have a slightly bitter aftertaste, are two other flavor modifiers, S6821 and S7958, which are "bitter blockers". If these bitter blockers can improve the flavor profile of this rapidly-growing and natural sweetener to give it additional growth and dominance, not only would Senomyx raise a lot of eyebrows, but so would Stevia First Corp as its success depends on the growth of the stevia market. The company has already received international regulatory approvals for many of its flavor modifiers with regulatory filings now getting underway for the S52617 modifier for sucrose and HFCS. These approvals come in the form of the Generally Recognized As Safe [GRAS] designation in the U.S. and the additional confirmation from the Joint FAO/WHO Expert Committee on Food Additives [JECFA] announced in July. The latter allows several additional international markets for S6973, S2383, and the two bitter blockers, S6821 and S7958.

In a sector in which mergers and acquisitions are fairly common, Senomyx can certainly begin getting more speculative investor attention as it has collaborations with Ajinomoto, Firmenich International, Nestle, and PepsiCo underway. The current $75 million market capitalization for the company could become tempting if it can legitimize its product line and allow one of these or another larger food/beverage company to gain a competitive edge due to Senomyx's modifiers. The company is currently generating revenue to the tune of $15.1 million in 1H 2012 versus $15.7 million in 1H 2011, and it ended 1Q 2012 with $47.9 million in cash and "highly liquid assets". Senomyx's 1H revenue was primarily due to the collaborations with PesiCo and Firmenich, which accounted for roughly 79% of its revenue. The company's cash burn rate is fairly contained with operation activities consuming $6.2 million in 1H 2012, a testament to the company's cost-cutting and investor-friendly financial management policies. Like STVF, the company is still operating in the red, but has a much more stable financial footing with comparable upside and a more diverse, but still unproven, product line.

Investment potential in society's sweet tooth can be promising with the right choices made. As potential investors consider each of the aforementioned possibilities, there are many choices to be made pertaining to sales potential. If Ajinomoto wishes to remain a major player in the reduced-calorie sweetener field, it has a lot of decisions to make as its aspartame sales will likely continue. Its firm financial base affords it the finances to consider an acquisition of another current or future player in the sector. Stevia First Corp is a high risk, high potential reward player that is taking a unique approach of supplying stevia leaves with a consistent flavor profile. It can be considered to be both a member of the low calorie sweetener field and an agricultural entity, the latter of which could enable it to be eligible for financial assistance from the Federal Government, although this hasn't been mentioned in any of the company's online filings, website or press releases. Senomyx is another interesting company in the sector with a unique approach to calorie reduction by reducing the amount of sweetener necessary for the same perceived sweetness via its platform of flavor modifiers. These modifiers target the huge current markets of sucrose, HFCS and the new low-calorie leader, Splenda® (sucralose). Applicable to the number two low-calorie sweetener sales leader, Senomyx's "bitter blockers" also provide the company possible exposure to the current fastest growing low-calorie sweetener by helping to improve its flavor profile.

Disclosure: I am long OTCQB:STVF, KO. 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.