With MannKind (MNKD) investors I often see a severe propensity to assess only the part of the equation that fits an investors desired goals. By example, I see investor after investor quoting revenue growth percentages and ignoring script growth percentages. There is severe folly in such actions and I will illustrate it with a simple example using Coca Cola.
Let's assume that a can of Coke is $1.00 and the price is plastered on the can. Lets assume that 1,000,000 cans of Coke sell in Q1. Here is what we have.
- Cans sold = 1,000,000
- Price per can = $1.00
- Retail Revenue = $1,000,000
Now let's say that Coke decides to increase the price of its cans to $1.50 in Q2, but there are still a lot of cans of $1.00 coke on the shelves. Coke will let those sell through. Let's assume that half of the cans sold in Q2 were at $1.00 and half were at $1.50. Let's assume that growth of cans sold is 20%. Here is what we have:
- 20% growth in cans sold means that 1,200,000 cans sold
- 600,000 cans were at $1.00 = $600,000
- 600,000 cans were at $1.50 = $900,000
- Total sales would be $1.5 million, or 50% growth.
Now, if one were to look only at the retail growth percentage of 50%, one might begin to think that Q3 will replicate the dynamic and deliver $2,250,000 in revenue. But lets look at what happens:
- Cans sold grows 20% to 1,440,000
- Revenue is now $1.50 per can, which delivers $2,160,000.
It misses the projection, but not by much. Instead of 50%, the revenue growth was 44%. The investor then uses that number to project Q4 at $3,110,000.
In Q4, the cans sold grows 20% to 1,728,000. The investor is expecting revenue of $3.1 million, but the actual revenue comes in at $2,592,000, which is now the same 20% that cans sold grows. In that investors mind Coke was off by over $500,000.
That investor set himself up for failure because they decided to only look at the part of the data that was impressive and never recognized that such a though process was doomed from the start.
The point is simple. An investor needs to look at all data. With MannKind, the Afrezza SKU's changed in Q2. Q3 presented a mixed bag of old price points and new price points. The beginning of Q4 was a mix. Beginning in November, it is apparent that the old SKU's are gone and the new are in. This is why Q4 will present about 18% to 20% script growth, but nearly 50% revenue growth.
Q1 of 2018 will see the revenue growth begin to line up closely with the script growth. There are many investors that are interpreting the pace of revenue growth as something going "exponential" or as a "hockey stick" forming. The problem with such an assessment is that actual script sales traction is not following suit. If you make an investment thesis based on 50% revenue growth in Afrezza, but script sales do not increase by 50%, you will be scratching your head a quarter or two from now.
What investors want to do is model all of these dynamics. We can recognize that the revenue per script will spike and then level off to mirroring the script traction. As we all know, every action creates an opposite and equal reaction. This holds true (for the most part) in accounting. The new SKU's deliver the benefit of more revenue per script and a revenue growth percentage that looks great. The reaction is that the percentages will then move down and the "exponential" or "hockey stick" will cease to exist.
As I model, I assess the script numbers, retail sales, time of year, holidays, sector, other drugs that are on the market, marketing dollars, size of sales force, cash available to support growth, and other factors. You can not bake a cake with one ingredient, so why assess the sales prospects of a product with one metric?
Being a smart investor means understanding the story in a realistic manner AND understanding what the average investor out there is thinking. There are times when those with foolish thinking drive the stock, but the numbers come out each quarter and those that were realistic gain the advantage.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.