Tuesday, November 23, 2010

3S Bio ( Nasdaq - SSRX )

3S Bio (SSRX $16.00) is a leading Chinese provider of genetically engineered pharmaceuticals.  The company's two lead products were developed internally and currently hold the largest share of their respective markets.  EPIAO is an injectible version of EPO, the drug that put Amgen on the map in the 1990s.  It's used to stimulate red blood cell production to treat anemia, primarily in post surgical and cancer applications.  That line accounts for 60% of sales and has a 42% share of the Chinese market.  TPIAO treats chemotherapy induced platelet deficiencies and represents 30% of sales with a dominant market share.  Foreign compeition was blocked out of China while TPAIO went through the evaluation stage, but those restrictions were lifted earlier in 2010.  3S Bio also markets three older products through its direct sales force.  Two additional products have been licensed from foreign drug companies.  Those drugs are in clinical trials and probably won't be introduced for 2-3 years, assuming approval is obtained.

Demand is growing at a fast pace.  China implemented a comprehensive health care reform law in 2009, which expanded coverage to most of the country's population.  Economic stimulus funding has generated further impetus.  Proliferation of advanced medical technology is increasing the number of procedures performed.  And the basic need for treatment is rising due to the rapidly aging Chinese population.  The entire medical industry is expanding at a 10%-15% annual rate.  3S Bio is growing even more quickly, in the 25%-30% area, due to its focus on the high end of the market and a superior sales force.

We estimate 2010 sales will rise 25%-30% to $58-$60 million.  Earnings are likely to end relatively flat with those of the prior year at $.65-$.70 a share due to a higher tax rate and greater R&D spending.  Next year sales could reach $75 million as 3S Bio's two lead products retain their leading positions in China's fast growing pharmaceutical industry.  Income could attain $.75-$.80 a share, depending on how well margins hold up.  3S Bio recently doubled production capacity, which will cause unit costs to increase until volume catches up.  Further hikes in R&D spending are possible, too.

The long term outlook is bright.  3S Bio is managed by American trained scientists who enjoy a stellar reputation among foreign executives.  Its proven track record could lead to increasingly large joint venture relationships.  Finances are robust, with $109 million in the bank and no debt.  New products already in the pipeline have the potential to amplify performance dramatically.  In 2-3 years the current line-up could yield sales of $125 million, and earnings of $1.40 a share.  New products and joint ventures could generate substantial leverage beyond that.   Applying a P/E multiple of 25x suggests a target price of $35 a share, potential appreciation of 120% from the current quote.  3S Bio represents a high potential acquisition candidate, moreover, so a higher valuation is possible.

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Friday, November 19, 2010

Computer Modelling Group ( CMG - Toronto Exchange ) - Follow-up Report

Computer Modelling (CMG $21.00 Canadian) reported excellent on target Q2 (September) results.  Sales advanced 47% to $13.3 million.  Earnings climbed 73% to $.26 a share, excluding non cash stock option expense.  The company sells its reservoir modelling software to the energy industry both as a perpetual license and on a recurring year to year basis.  Up front revenue is greater on perpetual sales.  That format does generate some recurring revenue in the form of annual maintenace contracts, however, ensuring customers they receive technology upgrades when they become available.  New unit sales typically are tied to new development projects.  Computer Modelling doesn't break out unit volume but it appears activity picked up sequentially in Q2, bolstered by stronger petroleum prices and improving access to capital.  Results also benefitted from a modest pick-up in perpetual license sales, especially compared to the first quarter when they were practically zero.  Year to year renewals still account for a majority of the business.

The next generation DRMS ("Dynamic Resource Management System") went into service in Q2.  The initial applications will be at sites being developed by Computer Modelling's software partners (Shell and Petrobas).  Those energy giants are each paying one third of the product development costs, although Computer Modelling will retain 100% rights to the technology.  The partners get first crack at the system, though, and that lock-up probably will extend for awhile.  Commercial sales to outside customers are likely to provide a major boost to results through the decade.  But that contribution is likely to modest over the next year or two as Shell and Petrobas fine tune the software and reap the initial benefits for themselves.

The core operation remains in a high growth mode.  New oil discoveries are being made, but they have become increasingly complicated to exploit.  Most of Computer Modelling's sales continue to come from North America.  Interest is building in the Middle East, Asia, and Africa, however.  Those markets promise to keep results marching higher well into the future.  We estimate fiscal 2011 (March) income will reach $1.10-$1.30 a share (Canadian) on sales of $55-$60 million.  Further improvement is likely next year, especially if inflationary pressure increases in the energy complex.  By then the DRMS line should start making a substantial contribution.  Note - Computer Modelling's stock also trades in the U.S. under the ticker symbol CMDXF.  Trading is more liquid in Toronto.

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Saturday, November 6, 2010

Central European Distribution ( CEDC - Nasdaq ) - Follow-up Report

Central European Distribution (CEDC $26.75) reported Q3 results that were below our expectation.  We had anticipated a down period.  Results came in even lower due to a summer heat wave in Eastern Europe, which encouraged drinkers to switch from vodka to beer (which the company doesn't manufacture).  Fires in Russia contributed added pressure.  And Central European spent a lot of time and effort selling off its Polish distribution business and restructuring its Russian operations.  Earnings slid 75% to $.12 a share.  Sales 16% to $157.8 million.  Central European predicts a better showing in Q4, which is its strongest selling season due to the holidays.  Still, full year earnings are likely to finish in the $1.50-$1.70 a share range, somewhat below our previous $1.75 a share estimate.

Things could pick up in 2011.  Pricing has improved in Russia, bolstered by government measures aimed at cutting into the black market.  Untaxed sales represent approximately 50% of the entire market at present.  Greater enforcement could divert more business to legal producers, as well, lending Central European a further boost.  How much of the black market the company will ultimately get its hands on remains to be seen.  Much of the illegal output is made at otherwise legal facilities, just on an extra shift.  And police and government officials are believed to benefit from various profit sharing arrangements with black market operators.  New entities may crop up if those enterprises convert to a legal format, blocking Central European from simply scooping up the extra business.

Competition is more intense now that it was in early 2000s, when the company originally entered the Polish vodka market.  Back then the Americans who ran Central European exerted superior management know-how and stronger finances to zoom past its competition and garner 30%-40% of the industry.  The company already holds about 20% of the Russian market.  Expansion from there are likely to be grudging, in the neighborhood of 1%-2% a year if everything goes great.

Outsize earnings gains may be difficult to achieve in the future.  Income could climb back to the $3.00 a share level over the coming 2-3 years, but a lengthier time horizon may be required.  Downside risk is limited by Central European's appeal as a potential takeover candidate.  Value investors may want to hang on and see some more cards.  Due to the company's uncertain earnings prospects, however, aggressive investors are advised to close out positions and reinvest the proceeds in a stock with more clear cut appreciation potential.