2023-04-29 04:20:36 ET
Summary
- Demographic trends are powerful and experience little impact from economic cycles.
- As the Millennial generation enters middle age and surpasses the number of Baby Boomers, the demand for medical screening and testing will increase.
- Exact Sciences’ non-invasive colorectal cancer screening test, Cologuard, will experience accelerated demand and revenue generation.
In a recent article focused on finding opportunities during a possible recession, I outlined three scenarios, or lenses through which investors might make purchase decisions, including downside protection, upside appreciation, and uncorrelated opportunities. In this article, the focus is on finding a business that is driven by micro factors specific to the business that are uncorrelated to the macro environment and broader financial markets.
This doesn't mean that the focus is on low beta stocks. In fact, the correlation of returns can be relatively high between a company's stock and the broader market during certain periods while the underlying economic drivers of the business are uncorrelated to the macroeconomic environment.
The specific driver that I am looking at in this article is the aging population, but within Gen X and older Millennials.
Aging Millennials
According to the Pew Research Center and U.S. Census Bureau , Millennials (those born 1981-1996) overtook the Baby Boomers as the largest generation sometime during 2019. The same research also showed that Gen X will overtake the Boomers by 2028. The Millennial generation in the U.S. is over 72 million strong and expected to peak at about 75 million in 2033 when net immigration and mortality balance each other out and the generation begins a slow decline.
Projected Population by Generation (Pew Research Center, U.S. Census Bureau)
Critical Cancer Screening
The aging population and the entry of the Millennials into middle age is a secular growth trend that means that the demand for certain medical testing and screening will increase at an accelerating rate, and for years to come. One company well positioned in this space to benefit from this coming of (middle) age is Exact Sciences ( EXAS ). The company, founded in the mid-1990s, specializes in diagnostics for early cancer detection. The most well-known test that the company has developed and has been marketing for several years is the Cologuard test. It is a non-invasive, early detection test for colorectal cancer. This is something that virtually all Americans are tested for in their forties. As the Millennial generation is now entering that age bracket, and with the relatively attractive feature of being non-invasive, it is reasonable to expect the growth in sales of this test to accelerate and to reach higher absolute levels.
The test itself is proprietary and patent-protected, giving Exact some monopoly power over the non-invasive, early detection space for colorectal cancer. This is a great example of intangible assets creating real value for the company and its shareholders. In fact, intangible assets, including goodwill and the company's intellectual property are valued at over $4.3 billion on Exact's balance sheet, or just over 69% of total assets.
Exact fits the screen of businesses that can perform well even during an economic recession because its business is unrelated to stock market returns, GDP growth rates, monetary and fiscal policy. Ultimately, the growth of its business is driven by the passage of time and the aging of the population, particularly in the U.S. If the U.S. economy slows, or even enters a recession, it is reasonable to expect this to have a limited impact on healthcare spending in the face of an aging population.
Recent Performance
Exact's stock price has been volatile since the company went public in 2001. Over the last 5 years, as illustrated below, the stock has been significantly more volatile than the S&P 500. The stock is far below its all-time high of nearly $160/share reached in early 2021 but has doubled since the lows it reached in October 2022. While this rebound has been significant over the last six months, I believe there is room to grow and the possibility of multi-year growth as demand for its products accelerates with aging Gen X and Millennials. If the stock were to reach its previously all-time high, that would represent a return of approximately 150% from its current price.
Valuation
Valuation for Exact, and many other biotech stocks, is tricky as accounting profits are not always earned. Looking at valuation based on price, sales, and book value is slightly better, but the information gained from these ratios is unclear. From the metrics for which there is complete information, it looks like Exact is trading below multi-year averages relative to its sales and book value. Again, the information that can extracted from these measures is unclear, making the dependence on the investment theme and future outlook that much more important.
Valuation Metric | EXAS | EXAS 5-Year Average | % Difference to 5-Year Average |
P/E GAAP ((FWD)) | NA | NA | NA |
EV/Sales ((FWD)) | 5.76 | 11.30 | -49.05% |
Price/Sales ((FWD)) | 4.96 | 11.21 | -55.74% |
Price/Book ((FWD)) | 3.83 | NA | NA |
Price/Book ((TTM)) | 3.71 | 7.86 | -52.82% |
Valuation Versus Peers
When Comparing valuations across peers, the same problems arise. The information is spotty given the lack of consistent accounting profits, and the ratios are sensitive to the variability in sales from one period to another, resulting in a wide array of ratios. From the information below, it appears that Exact has a more conservative valuation than this peer group. That said, whether comparing the valuation to its historical trends or to that of peers, investors are not basing investment decisions within biotech on valuations, but on future growth.
Valuation Metric | EXAS | Sarepta Therapeutics ( SRPT ) | Guardant Health ( GH ) | Legend Biotech Corp. ( LEGN ) |
P/E GAAP ((FWD)) | NA | NA | NA | NA |
EV/Sales ((FWD)) | 5.76 | 8.99 | 4.85 | 45.33 |
Price/Book ((FWD)) | 3.83 | 13.19 | NA | 33.05 |
Price/Book ((TTM)) | 3.71 | 27.90 | 36.97 | 15.26 |
Profitability
In reviewing various profitability metrics, the only one that appears meaningful is the gross profit margin. At over 70%, Exact is performing in line with its 5-year average. Once positive margins can be reached at the bottom line, the profitability growth for the company should be impressive. Top line revenue growth has been compounding at an annual rate of about 38% over the last 5 years according to the company and expected to continue. For the full-year 2023, Exact expects to generate revenue of about $2.3 billion and positive adjusted EBITDA up to $25 million. However, the company will continue to reinvest significant cash into CapEx with the 2023 spend estimated at $120 million.
Profitability Metric | EXAS | EXAS 5-Year Average | % Difference to 5-Year Average |
Gross Profit Margin ((TTM)) | 72.44% | 74.47% | -2.73% |
Net Income Margin ((TTM)) | -29.91% | -34.27% | NM |
Return on Common Equity ((TTM)) | -19.39% | -22.12% | NM |
Return on Total Assets ((TTM)) | -10.01% | -9.81% | NM |
Return on Total Capital ((TTM)) | -6.88% | -7.65% | NM |
Covered and Included
Exact's stock is well covered by Wall Street with 19 analysts currently covering the stock. Beyond analyst coverage, the stock is closely followed, and owned, by a number of thematic ETFs. Notable owners include two ARK funds managed by Cathie Wood, the ARK Genomic Revolution ETF (ARKG) and the ARK Innovation ETF (ARKK). In the genomic fund, Exact represents a 10% weighting while in the innovation fund it is nearly a 6% weighting. It is held in much smaller weightings in many other ETFs focused on biotech, healthcare, small cap growth, as well as the iShares Exponential Technologies ETF (XT).
Inclusion in these funds provides a relatively stable shareholder base, liquidity for individual shareholders, and robust coverage of any developments at the company.
Risks
While I believe in the theme, as do the many thematic managers mentioned above, this stock remains speculative. From an accounting perspective, it is not profitable and doesn't generate positive operating cash flow. Reinvestment in future growth is important to the business, but it also drains cash. It is difficult to pinpoint a timeframe for when the company will consistently generate positive and meaningful operating cash flow and accounting profits.
While revenue has been driven in large part by Cologuard, the growth rates experienced in recent periods is not guaranteed. Furthermore, even with compound annual growth rates near 40%, expenses will need to be effectively managed in order to generate positive cash flow and profits.
Although direct competition, particularly in the early detection non-invasive colorectal cancer space is unlikely, there is no guarantee that those that should be screened will receive screening. And if they do, many may continue to choose the more invasive colonoscopy instead of Cologuard.
Final Thoughts
This is by far the most speculative stock that I have written about on Seeking Alpha. The risks are significant for Exact, as they are for most biotech companies. The financial performance based on standard accounting practices is difficult to wrap your head around due to lack of accounting profits and in many cases, significant cash burn. Because of this, investing in Exact or most other biotech companies is risky, and requires a belief in the long-term investment theme. For Exact, I believe that there will be increased demand for their early detection cancer screening tests. I believe that the ageing Millennial generation will be a significant driving force behind rapidly accelerating revenue for the company. However, even if this premise is correct and comes to fruition, there is no guarantee that company management will be able to extract real profits from those growing revenues. But as far as a business model that has the potential to thrive during any economic environment, and especially a recession, Exact has that. As always, any overweight or underweight position to this stock needs to be considered carefully to understand its impact on long-term total returns and long-term investment objectives. Thank you for reading. I look forward to seeing your feedback and comments below.
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Exact Sciences: Ready To Benefit From Aging Millennials