Neogen Corporation: A Food and Cattle Safety-Testing, E coli Play

| About: Neogen Corporation (NEOG)
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In mid-August, E. coli 0157:H7 infected leafy greens from Natural Selection Foods (some sold under the Dole brand) hit 26 states, caused 187 illnesses, killed three people (by last count) and put 97 people in the hospital. The recall for bagged spinach and lettuce traced to California farms occurred on September 15, 2006.

Shockingly enough, this is the 20th outbreak of E. coli since 1995, half of which originated from California farms.

The FDA's Dr. David Acheson said that tougher regulations would most likely be necessary to curb these dangerous diseases that can be better avoided. He stated simply, "There are some longer-term issues that need to be addressed."

Neogen Corporation (NASDAQ:NEOG) is a micro-cap company that created the first handheld system for E. coli testing and the fastest to date. It makes and markets a dipstick Reveal Rapid system that can find E. coli in fresh fruits and vegetables in a matter of hours.

NEOG is my pick as the company that will profit from refined FDA regulations on the handling of food from the moment of growth. It's already well respected in the field. Since 1994 the USDA's Food Safety Inspection Service (FSIS) has used the company's rapid test for E. coli in the nation's beef supply.

Since 1994, the USDA's Federal Grain Inspection Service [FGIS] has awarded Neogen a contract for the exclusive use of its quantitative test for aflatoxin in grain commodities. (Aflatoxin is a fungus that makes animals and humans sick in large doses.)

With the spinach scare over for now, the FDA must push tougher food safety regulations. As Neogen is already involved with E. coli testing in the beef industry, it will be the first company to provide its food safety on-site testing kits to food producers across the country.

The company’s food safety sector has grown stronger over the past two quarters and will continue to grow following this highly dangerous E. coli debacle. The stock has a higher beta than I wish for, which is where the moderate risk rating enters the picture. As food safety regulations sit on the top of the FDA’s to-do list, NEOG will continue to provide and improve its on-site food safety testing systems, keeping its contracts intact and its profits improving. I anticipate a $40.00 price tag on this stock by the end of the 2007 calendar year.

Safer Food For Your Fork

Neogen Corporation was founded in 1982 and is based in Lansing, Michigan. It has 393 employees in four U.S. and two international locations. The company operates in the healthcare sector of the diagnostic substances industry.

NEOG develops, manufactures, and sells food safety testing and animal health products globally. Currently, it has more than 200 easy-to-use and extremely accurate diagnostic test kits.

In the company’s food safety segment, it offers diagnostic test kits that detect dangerous substances in human food and animal feed. This can include food-borne pathogens, natural toxins, food allergens, genetic modifications, ruminant by-products, drug residues, pesticide residues, and general sanitation concerns. These food safety products are available to food and feed producers and processors.

Neogen is a pioneer of rapid diagnostic testing, bringing to the sector precise and trusted on-site tests to replace complicated off-site methods. Neogen’s tests are quick, and require minimal start-up costs and training.

Neogen's tests use built-in controls to achieve confident test results. The company’s test kits are now accepted worldwide and are the gold standard for many domestic and international regulatory agencies and industries.

Every year since 1994, the USDA’s Federal Grain Inspection Service (FGIS) has awarded Neogen a contract for the exclusive use of its quantitative test for aflatoxin in grain commodities.

Similarly, the USDA’s Food Safety Inspection Service (FSIS) has used Neogen’s rapid test for E. coli O157:H7 every year since 1994 to screen the nation’s beef supply for the deadly pathogen.

Neogen’s GeneQuence Automated System, which is fully automated and performs multiple analyses at one time. It detects pathogens in raw ingredients, finished food products, and environmental samples. GeneQuence is capable of performing up to 372 samples at a time! It can detect the deadly E. coli O157:H7 that caused recent death and sickness in the spinach that originated in California, Salmonella, and Listeria.

Neogen’s new AccuPoint ATP Sanitation Monitoring System is a handheld unit that offers advanced sanitation monitoring.

Neogen’s AccuScan is a handheld unit that scans and stores results that food producers can access for Hazardous Analysis and Critical Control Point (HACCP) compliance and record keeping.

For food safety, Neogen also has simple dipstick tests called Reveal for Aflatoxin and Reveal for DON that detect pathogens in three minutes. Simple Reveal dipstick tests for ruminant by-products in feed and feed ingredients prevent the feeding of the by-products to other ruminants -- and help stem the possible spread of "mad cow" disease.

The company also provides test kits and reagents for the detection of dangerous food-borne bacteria, such as E. coli O157:H7, Salmonella, Campylobacter and Listeria, and rapid sanitation testing equipment designed to help ensure the safety and quality of food products.

Current investigations following the spinach incident have the FDA, state of California, the Centers for Disease Control and Prevention (NASDAQ:CDC), and the United States Department of Agriculture inspecting, collecting samples, and studying animal management, water use and the environment, all trying to find out safer ways to bring food from the field to your fork.

Possible sources of E coli infection include contaminated water, manure from nearby cattle farms, other animal droppings, and poor worker hygiene.

According to FDA guidelines, 'good agricultural practices' include irrigating with clean water, providing toilet facilities for pickers, making sure animals don't contaminate produce in packing sheds, properly washing fresh produce, and maintaining correct temperatures during shipping.

E. coli can exist in soil for up to 120 days. Once it's a contaminate, it's hard to get rid of, so testing is invaluable in early food production stages. Cooling will keep E. coli from growing but not kill it and washing is ineffective.

The fresh cut vegetable sector will increase testing for bacteria, which puts Neogen in the top spot for gaining market share following the tragedy. NEOG's test that detects E. coli in vegetables and fruits is called Reveal Rapid. NEOG was the first to come out with such a product, and it remains the fastest, turning over results in a matter of hours.

A Safe Stock Story

Over the last five years, NEOG has continued to return consecutive gains to investors. In one year, it has returned gains of 16.04%. The stock has more than doubled that over three years, and has returned 75% over five years.

According to the company’s monthly chart, successive rising waves forecast a high of $30.00 within the next six to eight months.

NEOG is also known for its strong quarter earnings growth and their effect on the stock's performance. On July 25, the company’s fourth-quarter earnings caused NEOG’s $1.00 per share spike, accompanied by higher-than-average trading volume.

On September 26, when the company announced its first fiscal quarter results for 2007, NEOG’s stock jumped $0.65 and enabled it to gain support at the 200-day Moving Average.

NEOG ran from $10.00 per share to $25.00 per share in a year's time. At a current price of $20.00 per share, our next new high top before a correction should be $30.00 within the next six to eight months. I expect $40.00 per share by the end of 2007 as the FDA begins to regulate the food industry more tightly, making requirements for food safety instead of 'guidelines.' With NEOG already having contracts with both the Federal Grain Inspection Service and the USDA Food Safety Inspection Service, NEOG will be a winner in this war against food-borne pathogens.

Promising Results

Neogen is a micro-cap stock valued at $190.5 million. Its profit margin is very strong at 11.02%, with a return on assets of 9.84%.

Its quarterly revenue growth year-over-year is high at 20.50%, as is its earnings growth, at a 12.40% clip.

It currently has no debt and cash in pocket of $5.47 million.

Its numbers speak for themselves. On the annual scale, NEO made $5.1 million in net income during 2004, followed up by $5.9 million in 2005. Its last fiscal year was up 34% from the year before with net income of $7.9 million in 2006.

Gross profit increased from $27.5 million in 2004 to $37 million in 2006. That’s an increase of 35% in only two years!

The last two fiscal quarters have been amazing, especially for the company’s food safety sector, which is our focus industry for this stock. Neogen posted high sales for its 2006 fourth quarter, stating that its earnings "grew 35 percent year-over-year on improved sales across all product lines."

Specifically, Neogen’s testing kit sales increased. Lon Bohannon, Neogen’s president and COO state that he “was also very pleased to see that Food Safety diagnostic sales, which includes test kits for pathogens, natural toxins, and food allergens, grow by more than 10% on a same-store basis for both the third and fourth quarters.”

For its full 2006 fiscal year, earnings were $0.92 per share on revenue of $35 million, up 24.11% from the year before.

For its first quarter of the 2007 fiscal year, which ended in August 2006, NEOG stated that its food safety revenue continued to flourish, pushing the company's profits up 20% this quarter (double the quarter before). Revenue in its food safety products rose 48% alone to $11.4 million.

According to the company, this was mainly due to sales of natural toxin testing products; which increased 25% amid heightened concern over the potential for aflatoxin in corn in some parts of the U.S.; Aflatoxin is a fungus that can make both animals and people sick.

Neogen's first quarter 2007 is the sixth consecutive quarter of sales increases over 20%, according to James Herbert, Neogen's CEO and Chairman.

In addition, the lack of debt I mentioned earlier is due to the NEOG's past quarter. The company made $12.2 million this past June after offering 650,000 shares of common stock. The revenue from the stock offering paid the company's bank debt and the remainder was added to cash balances.

NEOG now has $17.5 million in its coffers to pursue more growth strategies, which will be focused primarily on its growing food safety sector.

Future Outlook

Average analyst estimates for the current quarter are $0.29 per share. It's expected that NEOG gain $0.20 per share next quarter and $1.04 at the end of this fiscal year in May 2007.

As the FDA continues to inspect fields and analyze the origins of the recent E. coli poisoning, NEOG will continue to renew its contract s with federal agencies to provide the quickest tests on soils, water, and fresh fruits and vegetables.

I expect NEOG to take its excess cash and fund new research and development, as well as refining its current product line.

The FDA will place tighter regulations on farm produce, eliminating voluntary practices; NEOG will be part and parcel of those regulations, and even private farmers will enlist the company's help in protecting themselves from future food-borne pathogen outbreaks.

I anticipate even stronger earnings growth for Neogen going into the rest of the 2007 fiscal year, due to strong sales in its food safety segment, which will help promote this stock's growth.

NEOG 1-yr chart:

NEOG 1-yr chart

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