HRTX - Why Heron Therapeutics Is A Compelling Buy Into 2024

2023-11-30 09:00:00 ET

Summary

• Heron Therapeutics develops solutions for pain and discomfort associated with chemotherapy and surgery, with four FDA-approved products.
• The company underwent a leadership change and implemented a plan to improve efficiency and profitability.
• Zynrelef, an opioid alternative, has the potential to become one of Heron Therapeutics' main value drivers.
• From a multiples-based valuation perspective, HRTX looks decidedly undervalued. I posit it has up to a 47.1% upside potential with a $2.02 price target.

Heron Therapeutics, Inc. (HRTX) is a biotechnology company headquartered in San Diego, California. Originally known as A.P. Pharma, Inc., the company rebranded to Heron Therapeutics, Inc. in January 2014. The company develops solutions for pain and discomfort associated with chemotherapy and surgery. HRTX has successfully introduced four FDA-approved products: Sustol and Cinvanti for CINV and Zynrelef and Aponvie for pain after surgery and PONV, respectively. Notably, Zynrelef is an opioid alternative, which I think could quickly become one of HRTX's main value drivers going forward. Moreover, recently, HRTX underwent a leadership change with the appointment of Craig Collard as CEO and Adam Morgan as Chairman. As a result, a plan to advance efficiency and profitability was initiated in June. These developments and promising product pipelines, coupled with HRTX's relatively undervaluation, make it a compelling investment alternative in biotechnology. In particular, I estimate up to a 47.1% upside potential from current levels, with a $2.02 price target per share. Hence, I rate HRTX a good "buy" and worth monitoring closely.

Business Overview

Heron Therapeutics is a commercial-stage biotechnology company based in San Diego, CA. It was founded in February 1983 and was initially known as A.P. Pharma, Inc., before it changed its name to Heron Therapeutics, Inc. in January 2014. HRTX develops agents to alleviate pain and discomfort produced by chemotherapy or surgery.

HRTX 's first commercial product approved by the FDA was Sustol, an extended-release injection to prevent chemotherapy-induced nausea and vomiting chemotherapy [CINV]. The sales of this medication started in October 2016. The second FDA-approved product was Cinvanti, which started commercialization in January 2018. It is a receptor antagonist aprepitant for preventing CINV, complementing other antiemetic agents.

Other HRTX products are Zynrelef and Aponvie, used for acute care solutions to prevent postoperative pain and post-surgery nausea and vomiting, respectively. The FDA approved Aponvie in September 2022 to treat postoperative nausea and vomiting [PONV]. The commercial launch of Aponvie was in March 2023. Likewise, Zynrelef was given FDA approval in May 2021 and is typically used as an opioid alternative. During its clinical trials, Zynrelef provided extended pain relief after surgery, lasting up to 72 hours, making it also a viable analgesic after surgery. In fact, its effects were noticeably better than a bupivacaine solution, which can cause opioid dependency. Unlike bupivacaine, Zynrelef's use resulted in patients with reduced opioid dependency compared to those who received bupivacaine.

Heron's Strategic Shift and New Leadership

Nevertheless, a notable development occurred on April 3, 2023. HRTX announced the appointment of a new CEO, Craigh Collard. The board also elected Adam Morgan as Chairman. The CEO and Chairman's roles were separated, and the board was reduced to seven members. After the corporate restructuring in June, HTRX implemented a plan to move forward with profitability by the end of 2024, seeking to improve efficiency. The project included a decrease in general and administrative expenses, renegotiation of contracts, and a reduction of 25% of the 203 employees. This plan aims to generate around $75 million in cash savings through 2025, $45 million of which are operational savings.

As a result of this plan's application, on November 14, HRTX published a news release reporting that the company is increasing the guidance for full-year 2023 for the oncology brands from $104 million to $106 million from the prior range of $99 million to $103 million, with a full-year net sales in the range of $123 million to $125 million. The cost reduction plan decreased operating expenses by 26% in 2023 compared to 2022. While these are welcomed news given HRTX's ongoing losses, it's also somewhat concerning that it might also affect its R&D efforts going forward. Naturally, time will tell, but HRTX is still a relatively small company, and these cuts are undoubtedly meaningful.

Oncology is Key, but don't Discount Zynrelef

Moreover, in the last earnings call concerning product performance, HRTX executives commented that Sustol and Cinvanti have a stable revenue base with net sales of $26.7 million for the quarter and $79.9 million year-to-date. Aponvie and Zynrelef continue to grow, and a marketing strategy is ongoing to capitalize on the strengths of these products in their respective markets. Collard emphasized that the oncology products bring steady profitability. However, Aponvie and Zynrelef have a large growth potential because they could become multi-hundred-million-dollar products. Thus, this could be a tremendous value driver for the stock in the coming years. Also, Zynrelef's label expansion for pain in other body parts would allow targeting additional orthopedic procedures, increasing the market reach. This would be a welcomed modification to their current IP, which could unlock different revenue verticals for shareholders.

Hence, HRTX is a company that can be more or less understood as combining two overall segments. First, HRTX's oncology franchise revenues mostly come from Cinvanty and Sustol. These are the bulk of the company's sales. In fact, HRTX expects to make roughly $123 million to $125 million for the full-year revenues, of which $104 million to $106 million will come from the oncology IP. This was a revenue guidance increase given this last quarter, which means the oncology segment outperformed even management's expectations. In other words, this division is now roughly 85% of the company's total expected revenues.

Therefore, approximately 15% of total revenues come from the acute care franchise. This comprises Zynrelef and Aponvie, which notably have interesting potential for future growth. Zynrelef, in particular, should benefit significantly from the coming label expansion and variations of the IP, such as vial access needles and pre-filled syringes. Theoretically, this could boost Zynrelef's patient base usage, enhancing HRTX sales. Still, as of today, this acute care franchise has roughly 15% of total sales and, for the last quarter, contributed just $4.7 million to total revenues. While this is still not the main revenue contributor, it could grow over time to become one of HRTX's main value drivers.

I think it's key to understand how important Zynrelef can become for HRTX going forward. For context, this drug is the first and only extended-release local anesthetic with Phase 3 studies. This is key because, if successfully developed and commercialized, Zynrelef could quickly become a viable alternative to opioids for pain management post-surgery. This means Zynrelef could gain the narrative as a drug that helps against the opioid epidemic in the US and quickly become an important revenue contributor to HRTX at the same time. Since 2020, Zynrelef has made significant strides toward wider approval and acceptance and is now well on its way to becoming the gold-standard alternative in pain management.

HRTX Looks Decidedly Cheap

In my view, Zynrelef and HRTX's revenue potential derived from the acute care franchise is being significantly underestimated. I believe that the current $4.7 million in quarterly revenue contribution is relatively small compared to its potential if it becomes a viable alternative to other pain relief methods, particularly opioids. Still, even without the revenues from the acute care franchise, the oncology franchise itself is already bringing enough revenues to make HRTX an interesting investment proposition.

From a numbers perspective, if we used HRTX's current guidance, we can derive a multiples-based valuation to help us assess its current value. In this sense, HRTX could make about $125 million in revenues for the year on the higher end of its guidance. The company also has $77.4 million in cash, $180.0 million of total debt, and a $205.60 million market cap, resulting in an enterprise value of $308.2 million. Hence, this implies an EV/Sales ratio of 2.47, well below the sector's EV/Sales ratio of 3.24 . This suggests that HRTX is likely undervalued to some extent at its current price tag.

Moreover, we can also interpret HRTX's fair value by using its sector's EV/Sales ratio and adjusting its debt and cash. This could give us an approximation of its fair value using a relative valuation approach. HRTX's $125 million in revenues would imply an EV of $405 million, which results in a reasonable value estimate for its equity of $302.4 million at its current cash and debt levels. This would be 47.1% higher than the current market cap, implying a $2.02 price target per share. Also, note that this is using 2023 full-year figures because, by 2024, analysts expect HRTX will generate roughly $140.18 million in revenues. This would further corroborate my assessment of HRTX's being undervalued. Also, it's worth mentioning that the HRTX traded as high as $3.26 per share in January of this year, so it's not out of the picture to assume it could do so again, given its seemingly cheap price tag.

Risks to the Investment Thesis

Naturally, while I remain bullish on HRTX's product pipeline, especially at its relatively cheap valuation, I think it's worth mentioning a couple of risks that could derail its rosy picture. In particular, HRTX's TTM cash burn of $100.5 million is extremely concerning, especially compared to its current cash position of just $77.4 million. This implies a cash runway of 0.77 years, which signals the urgent need to raise additional funds from either debt or equity. In particular, additional equity could significantly dilute current shareholders. For context, even a $20.0 million equity issuance would dilute the existing shareholders by roughly 10%, which is significant. Alternatively, issuing debt would bring relatively high interest expenses going forward, given the current high interest rate environment. Thus, this is a substantial risk that investors can't disregard.

Moreover, HRTX is not exempt from typical biotech risks related to its research and drug approvals. Yet, most of its revenues come from the well-established oncology segment, which should provide a stable revenue base for current shareholders. Nevertheless, to the extent that HRTX's value is derived from the potential of Zynrelef, risks remain. While I think this drug's potential is considerable, it's also worth noting the pitfalls shareholders could face if regulatory setbacks occur or R&D expenses are greater than anticipated. These risks, in particular, compound over HRTX's constrained cash runway, adding a layer of risk to the investment thesis.

Conclusion

Overall, HRTX is a promising company with a well-balanced product pipeline. It's often ideal when a stock has a good, healthy balance of IP that yields ongoing stable revenues that allow it to finance potentially promising research projects that can become meaningful value drivers. In my view, at its current stage, HRTX's value proposition appears to be undervalued, and this is likely due to its limited cash runway, which appropriately concerns investors. Nevertheless, while I foresee a cash raise in the company's near future, investors will again focus on HRTX's promising potential once we get past those concerns. In fact, at this current valuation, I wouldn't discount the possibility of being a takeover target, though that's beyond the scope of this article and steps into speculative territory. But the point is that I believe there are enough reasons to consider HRTX as cheap at these levels, and the upside catalysts are substantial. Either debt or equity issuance could quickly shift investors' focus toward HRTX's promising IP, which should soon result in higher valuations. As such, I think HRTX is a good "buy" for now and is worth keeping a close eye on.

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