Sonosite is a High Grow Healthcare Play

Sonosite $SONO is a leading player within a high growth niche area of healthcare. The company specialises in hand carried ultrasound systems and, is the leading player in the US in this area. SONO is competing with some very big companies like GE , Philips and Siemens but it has demonstrated the capability to lead this market. As such, this stock is a genuine takeover candidate for these companies or a larger company like Mindray.

Sonosite are involved in miniaturising and simplifying ultrasound for Point of Care (PoC) medicine. The company was spun out of a larger US company in 1998 and until now has established over sixty thousands installed users. The company's solutions are sometimes described as 'portable ultrasound' but this description does not allude to some of the growth drivers for Sonosite. Before going into them, it is useful to see how Sonosite is performing right now.

Sonosite SONO Q4 Results

Turning to the recent Q4 results

• Q4 Revenues of $89.3m vs. $83.7m estimates
• Including Non-Recurring Charges EPS was 41c vs. 36c estimates

Guidance

• Full Year Revenues of $310-325m vs. $312m estimates
• Full Year gross margins stable at around 71%
• Operational expenses of $184-186m
• Tax rate of 34%
• Analyst are forecasting EPS of $1.20 for 2011

Listening to the conference call the management are seeing a 50/50 split between international and US sales in 2011. International growth is seen as stable but low growth in Western Europe, however the emerging market and BRIC economies are seen as faster growing. A combination of organic revenue growth, new product launches in the second half and growing contribution from the Visual Sonics acquisition will increase the top line by 13-18% according to Sonosite.

One interesting aspect of this growth is that it will be more back end loaded, so investors can expect a 40/60 split of revenues in the two halves, with revenues in Q2 and Q3 being higher than in previous years. Margins are likely to stay stable because Sonosite is in-what the company sees as- the first of a three year sales cycle. Typically this means that sales costs, R & D and promotional activity are higher in the first year. After which, operating margins will expand in the next couple of years.

Sonosite estimates that it either held or gained market share in its major markets and the management do not appear to be planning any acquisitions for 2011.


Sonosite Growth Prospects

The growing usage of portable ultrasound for emergency procedures (where portability is an issue) is one area of growth as is increasing usage for certain medical procedures. In particular, advances in portable ultrasound technology are seen as creating a market for the machines to be used in procedures that would otherwise be covered by computed tomography (CT) or magnetic resonance imaging (MRI).

For example, patients who need on going antibiotics or chemotherapy will have a Peripherally Inserted Central Catheter (PICC) placed in them and, portable ultrasound is ideal for helping the nurse visually see how the instrument should be placed. Similarly, nurses use the machines to guide them in injecting anesthetics near peripheral nerves prior to surgery. For this type of hospital usage, Sonosite claims to be the clear leader with GE its main competitor.

Another growing usage is for detection of breast cancer, as ultrasound gives very high

Sonosite also cites Mindray as being a competitor in some of its markets and, they could be potentially an acquirer because Sonosite and GE have already settled a law suit. Furthermore, Sonosite should be attractive to the likes of Philips or Siemens who could immediately gain scale in the US by buying SONO.


Sonosite Evaluation

The stock trades at a share price of $36.94 which gives it a market cap of $498m and an Enterprise Value of $497m which makes it a small cap growth play. Analyst estimates are for EPS of $1.20 and $1.64 for 2011 and 2012 respectively. This hardly makes the stock cheap on a PE basis.  However, net income is only one side of the story, because SONO have been booking losses via buying back convertible debt. Furthermore, Sonosite is a highly cash generative business.

Given the numbers in the guidance above, it is entirely feasible that, for 2011, Sonosite will record $225m in gross margin and 40.4m in operating income. Assuming losses on debt repurchases similar to 2010 would give pre-tax profits of $29m and $19.1m in net income. Given traditional operating cash flow conversion, Sonosite could generate $33.5m in operating cash flow and around $31m in free cash flow (FCF).  This equates to a foward FCF/EV yield of  6.2% based on a current price of $36.94

This looks too cheap, so I bought some with a $45 price target.

Source:

iData Report, "U.S. Market for Ultrasound Equipment 2010"

Incyte Set for a Great Year in 2011?

Incyte Corporation $INCY looks set for an exciting year in 2011.Incyte has a few catalysts which, I believe, could lead to a substantial re-rating. I bought a small position, but would caution that the company’s outcomes will be guided by its lead compound. Any failure to execute on this program will hurt Incyte significantly. On balance, I think it is worth buying.

Incyte’s Pipeline in 2011

 Incyte could end the year with its first drug on the market with INCB18424. This drug is the co’s lead compound in clinical trials and, is a JAK-2 inhibitor which is currently in Phase III for myelofibrosis. Initial results were given in December 2010 and were positive, which suggests that if Incyte announce good final results by Q2 2011, than INCB18424 could get FDA approval by year end. In fact, this looks set to be the first approved JAK inhibitor for any indication. Incyte also has this drug in Phase II trials for Polycythemia Vera and Essential Thrombocythemia.

The second catalyst will be the results of the phase II trial with another JAK inhibitor, INCB28050, which is in clinical trials for Rheumatoid Arthritis. Incyte recently gave excellent Phase IIa results and, moved into Phase IIb trials in late 2010. I have featured this, amongst others, in an article on drugs in clinical trials for Rheumatoid Arthritis, found here

A third catalyst could be a partnership deal for INCB13739, which is an 11beta-HSD1 inhibitor. It gave good Phase II results in 2009 in reducing HbA1c, blood glucose, insulin resistance and cholesterol levels in patients with Type 2 Diabetes. Incyte are looking for a partner but as yet, have no deal.

Finally, Incyte has a few programs in early stage clinical trials including a Sheddase inhibitor INCB7839 for breast cancer.

INCB18424 a JAK-2 Inhibitor in Phase III Trials for Myelofibrosis

Incyte is partnered with Novartis for this drug. However, there are another two JAK inhibitors that, according to the principal investigator for both, Mayo Clinic, are producing significant responses in myelofibrosis. The first drug is YM Bioscience’s CTY387. According to Ayalew Tefferi of Mayo Clinic…

‘CYT387 not only works to reduce spleen size and to help with other symptoms, but it is the first in its class to show a significant response rate in anemia in myelofibrosis patients’

…and this anemia response affect, would appear to give YM Bioscience an edge. However, I would caution against getting too worried for Incyte, just yet. This was a Phase I/II trial with only 36 patients and CYT387 is years-and clinical trials-behind INCB18424.  YM Bioscience is looking for a partnering deal and, I suspect they will get it. CYT387 reduced spleen size by 50% in 37% of patients who achieved spleen reduction (97% of patients) in this trial.

The other potential competitor is TargeGen’s TG101348 whose Phase I/II results were so impressive that Sanofi-Aventis bought the company. More studies are underway.  Although the results were impressive, they too, are years behind Incyte’s drug. According to Mayo, TG101348 reduced spleen size by 50% in 72% of the responders (95%) in the trial.

As for INCB18424, Incyte released data from the Phase III trial involving 309 patients

The primary endpoint was the response rate defined as the percentage of patients achieving a 35% or greater reduction in spleen volume at 24 weeks as measured by magnetic resonance imaging, or computerized tomography, comparing the rates in patients receiving INCB18424 or placebo. The response rate was 42% in patients randomized to INCB18424 versus less than 1% of patients randomized to placebo

The drug is also in a European 219 patient Phase III, trial, with results due by mid 2011.  According to the JP Morgan Presentation, Incyte feel that there are 16-18,500 myelofibrosis sufferers in the US and the potential pricing could be around $50k. They believe there are 95,000 PV/ET sufferers.

Assuming, they grab 25% of the myelofibrosis market (not all sufferers will be eligible) and 10% of the PV/ET markets this could give around 14k*50k=700m in US revenue in 5-6 years. A hand waving guess sees Ex-US sales royalty bringing in 10% of that figure, so possibly around 770m.

In addition, this is the type of indication that will see favorable demographics in future years, as the amount of older people increases.

INCB28050 a JAK Inhibitor for Rheumatoid Arthritis

This drug is in partnership with Eli Lilly. I have written extensively about the drugs in development for Rheumatoid Arthritis here. As discussed in the article, tasocitinib is the leader and is set to be a blockbuster drug for Pfizer. Furthermore, Rigel/AstraZenexa has R788 in Phase II trials and, Vertex is currently in Phase IIa with VX509.

Incyte has much to do, to grab market share in this potentially crowded space. INCB28050 Phase IIa results were excellent…

ACR responses improved between week 12 and week 24 achieving up to 72% for ACR20, 44% for ACR50 and 30% for ACR70 at week 24. Results seen at 12 weeks for placebo were 32% for ACR20, 13% for ACR50 and 3% for ACR70, and for patients treated with INCB28050 the results were up to 59% for ACR20, 35% for ACR50 and 16% for ACR70.

…and compare to tasocitinib in Phase III and R788 in Phase IIb. However, Pfizer are way ahead here and I find it hard to see that Incyte has a huge chance to grab a major market share. However, they may not need to!

Future Market for Rheumatoid Arthritis and INCB28050

This is very hard to predict. However, I want to look at the predicted sales for the TNF Blockers. TNF blocker biologics like Humira (injected on alternate weeks) Enbrel (injected once a week) or Remicade (intravenous every month or so) are the current ‘new’ class of drug for RA. According to a Reuters article, Humira sales in 2014 will be $8.5bn, Enbrel $8bn and Remicade $7.6bn.

These drugs are responsive in 70% of patients, including some who do not respond to the first line treatment of methotrexate. However, they are expensive and have significant side effects. JAK inhibitors tend to be taken orally, so they have an advantage and they may end up having better safety.

Adding up the 2014 forecast for TNF-blocker sales gives $24bn. I think JAK inhibitors will initially grab some market from the non-responders (20-30% of patients) and, in time, start to take market share from them. Analysts are forecasting $2bn for tasocitinib sales. If Incyte can achieve 5-10% of these sales this would give around $100-200m in US sales and, possibly $200-$400m including outside US sales. Assuming, a 17.5% royalty would give peak sales of around $50m

A Good Year for Incyte?

In 2011, Incyte are aiming for good results in Phase III in myelofibrosis plus submission by year end.  Incyte is also in Phase IIb in Rheumatoid Arthritis and, they may yet surprise with a partnering deal for the novel compound for type 2 diabetes.

Adding the two guesstimates together (770+52m) gives 822m by 2017, with 90% margin, 150m in SG&A and say, 170m in R & D, this suggests around $420m in operating profits. They have tax losses so I would expect this to drop into cash flow and give around $500m. They have enough cash before they will launch their new drug, so I think a figure of $1.5bn in cash by 2018 is not unreasonable. The current market cap is 1.97bn.

I bought some.

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Source:

Mayo Clinic ‘JAK inhibitors producing significant response in myelofibrosis patients’, physorg.com, accessed 13 Jan 2010

Reuters Article, ‘Factbox World’s top selling drugs in 2014 vs. 2010’

All Incyte Clinical Trial Data from Incyte Website, accessed 13 Jan 2010