EBS - Financial Woes Darken Emergent BioSolutions' Outlook (Rating Downgrade)

2023-08-14 01:23:21 ET

Summary

• Emergent BioSolutions addresses public health threats; recent layoffs and operational cutbacks aim to save over $100 million annually.
• Despite Q2 2023 revenue increase, Emergent faces alarming cash burn, significant debt, and a predicted negative 3-year revenue CAGR.
• Updated recommendation: "Sell" Emergent due to precarious finances; however, potential turnarounds and market sentiment could challenge this stance.

Introduction

Emergent BioSolutions ( EBS ) provides solutions for public health threats, addressing areas like CBRNE, emerging diseases, and crises like COVID-19. They generate revenue from sales, contract services, and R&D grants.

In my previous analysis , I noted Emergent's revenue decline in 2022 and Q1 2023. However, the FDA's OTC Narcan approval offers a growth avenue for Emergent amidst the rising opioid crisis. Emergent's strong reputation and existing infrastructure position them favorably. I recommended a "Buy" stance, seeing potential for long-term growth. Risks included competition from other Narcan producers, unpredictable regulatory changes, execution challenges such as pricing backlash, reliance on government contracts, public health threat uncertainties, and significant debt obligations which could limit growth flexibility and pose financial challenges.

Recent developments: Earlier this month, Emergent announced that it is cutting investments, laying off 400 employees, and reducing operations at multiple facilities to save over $100M annually.

The following article evaluates Emergent BioSolutions' financial health, highlighting alarming cash burn, significant debt, operational cutbacks, and stock price decline, culminating in a "Sell" recommendation.

Q2 2023 Earnings

Looking at Emergent's most recent earnings report , revenues for Q2 2023 totaled $337.9M, showing a 39% increase from Q2 2022's $242.7M. This includes a substantial 78% decrease in Anthrax MCM sales to $21.2M, a significant 32% rise in Narcan sales to $133.9M, and a huge increase in Smallpox MCM sales to $123.9M. Contract development and manufacturing [CDMO] services and leases saw a notable increase, with revenues reaching $29.1M. Q2 2023's operating expenses soared to $630.8M, driven largely by a non-cash impairment charge of $306.7M related to assets within the CDMO unit. R&D expenses dropped to $26M, primarily due to the sale of the CHIKV VLP development program. Selling, general and administrative expenses grew to $91.4M. Lastly, capital expenditures for Q2 2023 stood at $12.5M, a sharp 61% decrease from the prior year, and the company raised $9.1M from its ATM Program by selling 1.1M shares.

Liquidity & Balance Sheet

Emergent, as of June 30, 2023 , holds cash and cash equivalents totaling $88.6M. Notably, there is a significant decrease from December 31, 2022, where they had $642.6M. From the condensed consolidated statements of operations, the company has an operating loss of $441M for the six months ended June 30, 2023. Extrapolating for the entire year, the annual cash burn would be roughly $882M. Consequently, the cash runway is approximately 1 month. However, the company is making efforts to reduce operating expenses, so cash burn, theoretically, should be reduced moving forward. Furthermore, Emergent is carrying a notable debt of $903.2M (combining both current and long-term portions). Given the alarming rate of past cash burn and significant debt load, the company's liquidity, in my view, appears to be in peril.

Valuation, Growth, & Momentum

According to Seeking Alpha data: EBS has a complex capital structure with a market cap of $296.34M and an enterprise value of $1.13B, comprised of small cash holdings and substantial debt. Valuation metrics are somewhat challenging to interpret given the absence of P/E ratios, but the Price/Book at 0.31 and EV/Sales at 1.05 suggest potential undervaluation. The company's growth prospects are concerning, with a projected decline in revenues and earnings in the forthcoming years; the 3-year CAGR for revenue is at a negative -5.18%. Stock momentum is also negative with a year-over-year drop of 81.25% in its stock price, significantly underperforming the S&P500, which gained 6.14% over the same period.

Emergent, with a market capitalization below $300M, falls under the microcap category. Microcap stocks typically represent smaller firms with constrained assets and market presence, often missing a consistent track record or strong financials. Due to their low liquidity, scarce public data, and susceptibility to undue influence, they can exhibit significant volatility and risk. Investors are advised to tread carefully, undertake in-depth analysis, and think about diversifying to minimize potential risks.

Emergent Outlines Growth Strategy and Streamlines Costs

On their most recent earnings call , Emergent's management outlined several growth strategies and key messages. Firstly, they emphasized positive developments such as the sale of their Travel Health business, a $120M order from the U.S. government for ACAM2000, and a favorable trend in Narcan Nasal Spray sales in both the U.S. and Canada. They are also preparing for the launch of an over-the-counter variant. Secondly, the company has opted to reduce its emphasis on growth in the Contract Development and Manufacturing Organization [CDMO] sector, resulting in a reported impairment charge for the second quarter. Despite these changes, they remain dedicated to serving their existing clientele. Thirdly, Emergent has tempered its 2023 revenue expectations for the anthrax and smallpox franchises after discussions with the U.S. government. However, they remain hopeful for the future, particularly due to the approval of Cyfendus . There is also anticipation for increased procurement funding in 2024. The delay in the next procurement of Tembexa, another product, was also mentioned. Lastly, they announced actions to streamline their cost structure, which includes operational reductions at various facilities in response to changing demands. This move is expected to bring over $100M in savings from 2024 onwards. The overall tone was that of adaptability, with a drive to focus on profitable products, serve existing customers, and maintain financial resilience.

My Analysis & Recommendation

Since my "Buy" recommendation in May, Emergent BioSolutions has undoubtedly gone through a challenging phase. The 50% drop in stock price not only highlights the unpredictable nature of the biotech industry but also signals potential concerns about the company's current path and strategic choices. While I initially emphasized the firm's potential amidst public health concerns, recent financial metrics demand a reassessment. Reflecting on my previous analysis, I recognize that I might have underestimated the financial hazards. To enhance the prospects of my future recommendations, I have since incorporated a thorough discussion on liquidity and balance sheet in my articles.

In the case of Emergent, its alarming cash burn rate, coupled with a hefty debt burden, is deeply concerning. These financial headwinds, combined with the downsizing of 400 employees and the reduction in facility operations, in my view, paint a picture of a company in distress, aiming for survival rather than growth. Although Emergent has attempted to pivot with a renewed emphasis on core products, the financial data suggests that these measures might be too little, too late.

Despite the increase in Narcan sales and the potentially promising approval of products like Cyfendus and OTC Narcan, the overall outlook remains bleak. Management's intentions, while commendable in their drive to adapt and focus on profitability, come against a backdrop of a significantly shrinking cash runway and an expansive debt profile.

The valuation metrics, such as the Price/Book of 0.31 and EV/Sales at 1.05, though suggesting potential undervaluation, can also be interpreted as the market's dwindling confidence in the company's ability to turn around its fortunes. Considering the liquidity risks, uncertain future growth, and the challenging landscape they operate within, I believe a revision of the earlier investment stance is in order.

Given the current state of affairs and the looming financial uncertainties, I recommend investors "Sell" their holdings in Emergent. The company's precarious cash position, significant debt, and the uncertainties around its restructuring and growth strategies make it a high-risk proposition in the near to mid-term. Potential investors should exercise caution and consider other opportunities in the biotech sector that exhibit stronger financial resilience and clearer growth trajectories.

Risks to Thesis

When the facts change, I change my mind.

While I stand by my "Sell" recommendation, it's crucial to consider potential risks to this stance. Firstly, there's always the chance that Emergent's restructuring efforts, coupled with the focus on core products, could lead to a quicker-than-expected turnaround. The opioid crisis, for instance, continues to rage, and a consistent demand for products like Narcan could significantly bolster revenues. Additionally, unforeseen government contracts, accelerated product approvals, or strategic partnerships could rapidly alter the company's financial landscape. Lastly, market sentiment can be unpredictable. Even companies facing challenges can experience stock rallies based on broader market dynamics or sector trends. As always, investing carries inherent risks, and it's essential to be aware of all possible scenarios.

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