Enzymotec: Declining Expectations And A Lot Of Uncertainty

| About: Enzymotec Ltd. (ENZY)
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Enzymotec is facing a lot of issues recently and its share price was punished as a consequence.

Q2 quarter was disastrous as revenue fell more than 30% over the same quarter last year.

Expectations have come down significantly and the company is dealing with a lot of uncertainty.

Additional downside is possible.

Enzymotec's (NASDAQ:ENZY) Q2 report was disastrous. Although the company warned earlier about the short-term headwinds that it is facing, the results were much worse. Growing regulatory requirements in China and a severe drop in demand in the United States and Australia have affected the demand for Enzymotec's products, and the company reported a severe drop in revenue and earnings in the second quarter. The company faces a lot of uncertainty in the next couple of quarters, although management seemed confident in the future growth prospects. The company might be able to get through this rough patch and continue to grow in 2015 and beyond, but the significant amounts of risk make Enzymotec less desirable until the situation gets better.

Source: Stockcharts.com

Bad news

There was plenty of bad news for Enzymotec recently. The company reported Q2 earnings and revenue that were much worse than expected. Revenue in Q2 fell 39.8% to $9 million while the company was barely profitable with $0.02 earnings per share. Street consensus for Q2 EPS was $0.10, and reflected the falling trends in the last couple of months, as the company warned that there are certain headwinds in the business that might adversely affect the company's top and bottom line in Q2. However, the effects were worse than expected. The nutrition segment's revenue declined as a result of slower sales in China due to new government policy for the infant nutrition industry. The new policy created increased pricing pressure and competition from local and international brands. These changes have driven a higher than anticipated sales decline. Another source of weakness was the overall decline in the Omega-3 market which affected Enzymotec's krill oil sales in the second quarter. The company was particularly affected by the weakness in the United States and Australia. The decline in the market was a combination of increased capacity and supplier anticipation of a growing market, and is expected to increase competition and pricing pressure going forward. The growth in VAYA Pharma segment was also lower than expected. VAYA Pharma sales grew 40% over Q2 2013.

Enzymotec provided FY2014 guidance that was much lower than what the company expected three months ago. The company now expects full-year revenue between $46 million and $52 million, down significantly from the previous range of $68 million to $85 million. Non-GAAP EPS is now expected to be between $0.34 and $0.43, also down significantly from the previous range of $0.64 to $0.94. These figures would represent a serious decline from 2013, when the company reported revenue of $65 million and EPS of $0.79.

Overall, the second quarter was a disaster for Enzymotec and a steep drop in the share price is a consequence of the lower growth expectations and significant headwinds for the company going forward.

Good news

There are some indications of a better future for Enzymotec. Not much can be seen on the operational side, except for a 1,500 basis point improvement in gross margin, due to lower costs and the new manufacturing facility. VAYA Pharma segment is still growing and the company continues to increase its sales force in the U.S. and upgrade the infrastructure to support further growth. The company hired Rob Klein as the new CEO of VAYA Pharma. Mr. Klein has experience in the industry and should help with the growth of the VAYA Pharma business. Enzymotec also plans to grow VAYA Pharma outside of the U.S. through strategic partnerships. The company is in early stage discussions with multinational companies about cooperation in selling biopharma products worldwide.

Enzymotec's management believes that the headwinds are short-term in nature and that the growth should pick up in the following quarters. If the new guidance is conservative, there might be some upside in the next couple of quarters if the company delivers above the much lower expectations. A lot of negativity is already being built into the current share price, although there is still room for additional downside from here.

Estimates should continue to go down and downgrades and reduced price targets might affect the share price going forward

Given the sharp drop in full-year revenue and EPS guidance, we should expect further deterioration in analyst consensus estimates. The estimates are still quite high, and we should see reduced revenue and EPS estimates in the coming weeks. Additional downside in the share price is possible once the analysts start coming out with reduced price targets and downgrades (although just four analysts are covering the stock).

My previous price target for Enzymotec was $37.50. While the target may be reachable in a couple of years, I believe it to be highly unrealistic at the moment, given the steep downward changes in growth expectations. In the table below, you can compare the current 2014 consensus estimates with management guidance. If Enzymotec returns to growth in 2015, the company might trade in a P/E range between 15 and 25, but probably not higher given the recent disappointments and the newly found lack of faith in management guidance. Based on the mid-range of management EPS guidance, Enzymotec's upside seems quite limited and the stock could be trading at $10 or $11 in the next couple of months at the high end of the valuation range, while the potential downside is 30% or more. The company has around $3.20 in cash and no debt, so this should serve as protection on the downside. I would rate Enzymotec here as underperform with a $7 to $10 target price range. The odds are not great right now, but depending on the recovery in 2015, the situation could change for the better and if the company returns to growth in a meaningful way, the upside from the current price should be north of 50%.

Source: Yahoo! Finance, Enzymotec Q2 report


Enzymotec had an adverse change in fortune in the last couple of months. The company is facing strong headwinds and the growth has turned to the negative side in the second quarter, while the full-year guidance implies that the drop in revenue should continue throughout the year. Current consensus estimates are still very high, and Enzymotec might be vulnerable to further deterioration in estimates while reduced price targets and downgrades seem imminent. The odds of a higher share price in the next couple of months are slim, and further downside is more realistic at the moment. The wild card here is that the company might have guided full-year revenue and earnings very conservatively and left room for a significant beat in Q3 and Q4. If the company returns to growth in 2015, there is potential for a higher share price, but these potential catalysts are far from here and the weakness in the share price might persist in the next couple of months.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.