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Doug Loe Picks Top Canadian Pharma Stocks That Offer Shelter From

Published 14-01-2016, 06:07 pm

In a market where valuation trends appear to be directionless, we advise one of two strategies. One is to go defensive by deploying discretionary capital into dividend-yielding investments, a strategy for which Canadian .. 14 Jan 2016Special Interview

The new year is off to a turbulent start, with indices across all markets, including biotech, sliding downward in the face of headwinds from China. Canadian healthcare stocks offer a windbreak for biotech investors, however, especially if they select a diversified basket across the various sectors. In this interview with The Life Sciences Report, Euro Pacific Canada's Doug Loe details a basket of Canadian companies that offer shelter from the storm.

The Life Sciences Report: The landscape for pharmaceuticals was a bit rocky in the U.S. in 2015, particularly when it came to drug pricing. Did any of that volatility spill over into the Canadian biotech market?

Doug Loe: The sector is an eclectic one, with a multiplicity of publicly traded firms across all healthcare silos. These firms have generated strong returns in recent quarters, including even the specialty pharmaceutical sector, which has experienced some market value compression in Canada through corresponding valuation declines in two larger members of this category, Valeant Pharmaceuticals International Inc. (VRX:NYSE; VRX:TSX) and Concordia Healthcare Corp. (CXR:TSX). Because our healthcare universe is so diverse, and thus largely devoid of any singular factors that drive valuations one way or the other, we see the sector as an assimilation of "special situations" that merit company-specific research.

Markets have certainly been soft during early trading sessions in 2016, even in healthcare. But on a macro level, we do not see any sustainable factors unique to healthcare that would compress valuations longer term. The reason is mostly based on the fact that many firms in the drug and technology development arenas are pre-revenue/EBITDA (earnings before interest, taxes, depreciation and amortization), and thus experience value creation not through tangible economic performance-at least not yet-but from clinical/regulatory milestones pertaining to development initiatives that could create free cash flow down the road. Accordingly, in a market that is soft based on broad macroeconomic trends, stocks for which value is generated more by development milestones than by near-term free cash flow can often outperform, or at least have development milestones realized without direct impact from external economic factors.

The heightened scrutiny on the U.S. drug-pricing macro-environment has certainly impacted Canadian firms that sell pharmaceuticals in the U.S. market, Valeant and Concordia most notably because they are the highest-profile stocks of this category publicly listed in Canada. We believe sustained scrutiny on U.S. drug pricing is inevitable, and could continue well into 2016.

That said, we see no fundamental reason to expect specialty pharmaceutical profitability metrics to be excessively soft into 2016. Indeed, Valeant's own fiscal 2016 guidance, as modified in December, still predicts revenue/EBITDA of US$12.6 billion/US$7 billion. This guidance was characterized by some as being "slashed" from prior guidance, but implies a stratospheric EBITDA margin of 55.5%. Valeant has rest-of-world infrastructure from prior acquisitions that mitigate U.S. business risk, and we'll see how that geographic diversification reflects on performance going forward.

TLSR: We see from your healthcare coverage at Euro Pacific Canada that you research a broad spectrum of firms within different healthcare niche markets, including drug development, medical technology development, specialty pharmaceutical commercialization, and healthcare services. Taking each of these in turn, where do you see value creation within the drug development space for TSX-listed biotechs in 2016?

DL: On the drug development side, headline stocks with seminal milestones forthcoming this quarter are Telesta Therapeutics Inc. (TST:TSX) and Transition Therapeutics Inc. (TTHI:NASDAQ). Looking broadly at our clinical milestone expectations for 2016 in its totality, we expect two of our long-standing coverage stocks, Arbutus Biopharma Corp. (ABUS:NASDAQ; formerly Tekmira Pharmaceuticals) and Sophiris Bio Inc. (SPHS:NASDAQ), plus a more recent initiation of ours, ProMetic Life Sciences Inc. (PLI:TSX), to contribute materially to clinical event news flow over the next few quarters.

Taking each in turn, Telesta was a new coverage stock for us last year. Our initiation report was published in March, just weeks before the firm filed its biologics license application (BLA) in June for its mycobacteria-derived nucleic acid-cell wall complex biologic (MCNA) as a therapy for BCG-refractory non-muscle-invasive bladder cancer (NMIBC).

This niche cancer market is somewhat unique in that it is an interesting hybrid of characteristics describing advanced disease (it is already refractory to first-line therapy) and early-stage disease (it is still localized to its organ of origin). The drug itself has an interesting clinical/regulatory history, mostly because existing Phase 3 MCNA data was generated long ago, and was deemed by Telesta and former partner Endo International Plc (ENDP:NASDAQ) to be insufficient to support FDA approval.

Well, time rolls on, and the BLA was subsequently reviewed by an FDA advisory panel in November, which chose not to recommend approval even though the FDA actively encouraged Telesta to file available data, and even though MCNA was tested exactly as FDA recommended that BCG-refractory NMIBC therapies be tested, and while essentially meeting efficacy endpoints the FDA publicly stated would be medically relevant.

MCNA's PDUFA (Prescription Drug User Fee Act) date is in late February 2016. We believe the FDA could disagree with its advisory panel and approve MCNA as an early-stage bladder cancer therapy in patients who no longer responding to BCG but would prefer to delay removal of the bladder, if possible. The drug exhibited a one-year disease-free survival rate of 25% in an open-label, 129-patient Phase 3 study.

If you believe a trial with these descriptive elements is insufficient for approval, you are not alone; 18 advisory panel members agree with you! However, the FDA and the American Urological Association disagreed in a mutually endorsed set of clinical protocol guidelines published in 2014 in the journal Urology, and this stands as our best evidence that key regulatory leaders believe MCNA performed sufficiently well to be medically useful in BCG-refractory disease.

We will know in seven weeks if the FDA will sustain its views and approve MCNA. The drug is partnered with French specialty pharmaceutical giant Ipsen (IPN:EPA) for rest-of-world markets, and this partnership provides separate endorsement for MCNA's regulatory prospects. Our model projects peak U.S. MCNA sales by 2025 of US$188M, obviously predicated on FDA approval, and global MCNA-derived revenue that year, including rest-of-world royalty revenue from Ipsen of US$254M.

TLSR: Tell us about Transition Therapeutics.

DL: Transition is a long-time coverage stock, dating back to when its core pipeline candidate was a combination of the gastrointestinal (GI) hormone gastrin with a growth factor like EGF or GLP-1 to stimulate expansion and differentiation of beta cells in the pancreas into functioning islets in type 2 diabetic subjects. The technology was not effective in as broad a spectrum of diseases as hoped, and the firm moved on to new pipeline candidates that include a small-molecule central nervous system (CNS)-active scyllo-inositol formulation called ELND005.

The drug still lives in the pipeline even though data from a recently completed Phase 2 Alzheimer's disease (AD) agitation/aggression study were disappointing. Subgroup analysis identified a more responsive patient population that might form the basis for a new Phase 2 AD trial.

The company also has an Eli Lilly and Co. (LLY:NYSE)-partnered long-acting analog of the hormone oxyntomodulin called LY2944876, which Transition originally tested in a 60-patient Phase 2 study in 2013 and which Eli Lilly is now testing in a 375-patient Phase 2 study. We expect efficacy data in February 2016.

The drug performed well in the 60-patient study, engendering strong blood glucose-lowering activity with simultaneous weight loss at four weeks in obese diabetic subjects, and with once-weekly dosing achieving both of these endpoints. The larger, Phase 2 study that Eli Lilly is funding is a more rigorous challenge: testing efficacy over a longer course of three months and comparing it not to placebo but to another long-acting formulation in AstraZeneca Plc's (AZN:NYSE) Bydureon. There are no shortages of oxyntomodulin analog drugs in formal testing, but LY2944876 is the most advanced by far. We are optimistic in LY2944876's medical prospects, reflected in our Speculative Buy rating and CA$5.75/share price target.

TLSR: Why do you like Arbutus Biopharma?

DL: For Arbutus, which we have covered since 2009, when it was still an siRNA pure play and was called Tekmira Pharmaceuticals, we were encouraged to see the firm is on pace to achieve multiple clinical milestones this year-mostly, but not exclusively, focused on its growing therapeutic program targeting chronic hepatitis B.

The firm continues to enroll patients in a multiple-ascending dose Phase 2 study testing hepatitis B-targeted lipid nanoparticle-formulated siRNA TKM-HBV. We expect data on drug impact on hepatitis B surface antigen burden by Q4/16, and if this is positive, as prior published studies predict, we expect Arbutus to advance into formal Phase 2 hepatitis B studies combining TKM-HBV with one or more of the small molecule anti-hepatitis B agents that merger partner OnCore Biopharma brings to the pipeline, probably in 2017. Many of OnCore's preclinical candidates are expected to enter Phase 1 testing in H2/16.

Hepatitis B was one of the first markets in which Arbutus showed tangible gene knockdown with lipid nanoparticle-encapsulated siRNAs. Hence, we endorse ongoing efforts to target this high-prevalence infectious disease with siRNA formulations.

And, of course, Arbutus' siRNA delivery platform is amenable to other medical markets for which clinical candidates are already well advanced in ongoing studies, including liver cancer, where polo-like kinase 1-targeted TKM-PLK1 should generate gene knockdown and tumor response data by mid-2016. The Alnylam Pharmaceuticals Inc. (ALNY:NASDAQ)-partnered TTR-amyloidosis-targeted ALN-TTR02 could generate pivotal Phase 3 data from the 200-patient APOLLO trial in 2017. Any proportion of these programs that generate positive efficacy data along with positive gene knockdown data would be positive for our Arbutus valuation. We rate the stock as a Speculative Buy with a US$16.50/share price target.

TLSR: You also mentioned Sophiris Bio. What do you see there?

DL: One of our smaller-cap coverage stocks, Sophiris Bio recently generated positive Phase 3 data from a sizable benign prostatic hyperplasia (BPH) study testing a prostate gland-targeted bacterial toxin prodrug called PRX-302. Because of Sophiris' compressed market valuation, it may have evaded broader market attention for that reason.

This was a fairly large, 479-patient, placebo-controlled study in which PRX-302-treated patients (a single intraprostatic injection at day zero, with no follow-up dosing regimen) experienced a strong improvement in IPSS score, the standard measure for experimental BPH drugs. This accomplishment may seem trivial until you consider all the Phase 3 BPH assets that have fallen away in recent years. Sophiris shares have traded sideways recently despite strong price performance following data release, probably because it is abundantly clear that the firm needs to identify new sources of capital to fund a second, similar Phase 3 study prior to new drug application (NDA) filing.

But the Phase 3 data quality certainly provides justification for funding a second study, and we would expect that to commence before the end of 2016, capital considerations notwithstanding. The firm has a separate, 20-patient localized prostate cancer study that should generate data this quarter, and we are positive about how PRX302 could perform in this indication. We have a Speculative Buy rating and US$6/share price target on Sophiris.

TLSR: Would you comment on ProMetic Life Sciences?

DL: To complement the complexity already inherent in our coverage universe, we recently initiated on this clinical-stage plasma products manufacturer in Canada, for which we expect multiple clinical studies testing multiple plasma-derived therapies, such as intravenous immune globulin, alpha-1-antitrypsin, plasminogen, and C1 esterase inhibitor, to drive value over the next year or two.

All of these proteins have well-characterized biologic activity, and are already sold by plasma product developers, so ProMetic's clinical risk is quite low, if not nonexistent. The firm has affinity resin technologies that allow for higher-yield, higher-activity, higher-purity protein therapeutics to be extracted from human plasma than achievable with the legacy ethanol-based Cohn procedure, which most of ProMetic's commercial plasma product peers use.

ProMetic also has a high-profile small molecule benzene acetic acid derivative called PBI-4050 that is being tested in a few endocrinologic/metabolic indications, including in type 2 diabetes, where it nicely showed blood glucose control in a small Phase 2 study that will expand into a larger Phase 2 study later this year in chronic kidney disease and idiopathic pulmonary fibrosis (IPF), where the drug has shown promise in preclinical testing. The value of US$8.3B ascribed to pirfenidone developer Intermune on acquisition by Roche last year is not lost on us-or on ProMetic shareholders, we assume.

TLSR: One emphasis in your coverage is on specialty pharmaceuticals. Why do you like companies operating in this sector? Can you talk about some specialty pharma companies you particularly like?

DL: The term specialty pharmaceutical has lost some of its meaning, at least to capital markets, because it seems to describe any revenue-positive drug developer independent of whether it targets specialty physicians (assorted "ologists" who treat specific diseases), and whether it conducts any of its own research and development (R&D) to expand existing portfolio drugs into new markets. Mindful of just how fuzzy that term has become in recent years, we will take it to mean any commercial-stage drug marketer in our universe, regardless of how it acquired its commercial-stage drugs.

On the specialty pharmaceutical side of our coverage, we remain positive about the free cash flow-generating capabilities of emerging firms, even while some of their larger peers are experiencing market value compression. Our favorite stocks in this space are Cipher Pharmaceuticals Inc. (CPHR:NASDAQ; CPH:TSX) and Merus Labs Inc. (MSLI:NASDAQ; MSL:TSX). We also remain positive about revenue prospects for HIV-targeted Theratechnologies Inc. (TH:TSX) and omega-3 nutritional supplement developer Neptune Technologies & Bioressources Inc. (NEPT:NASDAQ; NTB:TSX).

TLSR: Would you like to start with Cipher?

DL: There is no denying that Cipher's market value has been challenged in recent months, even though share value has encouragingly stabilized in the US$3.50–5/share range. Much of the stock's recent softness seems to be market-wide, but it is undeniably true that Cipher's stock sustained huge downdrafts in the Q4/14 to Q1/15 period, when share value was at or above US$16share.

There is quite a bit to unpack here that is Cipher-specific. First of all, we suspect that investors are still reflecting on how to value Cipher's lead dermatology drug Absorica now that royalty revenue derived from this drug, while substantial at US$4.5M–5M per quarter and well above our original expectations, is not growing anymore, nor do we expect it to.

Second, investors are undoubtedly reflecting on the value of an acquisition Cipher consummated in Q2/15, a dermatology-focused revenue-positive firm called Innocutis that was generating negative annualized EBITDA (and our model assumes it still is), and that was funded mostly with new debt for which financial costs are clearly unfundable, at least right now.

But getting past those two factors, we see more opportunities than challenges. First of all, it is not negative in our view that Absorica generates such strong royalty revenue, even if it is not growing, because it provides substantial nondilutive capital that Cipher can redeploy into acquiring new commercial dermatology assets. This is consistent with our investment thesis-indeed, we were the first research team in Canada to formally predict Absorica's commercial success under partner Sun Pharma (NS:SUN)'s marketing leadership.

Also, we believe investors are undervaluing the magnitude to which achievable Absorica royalties were derisked by a settlement with Allergan Inc (N:AGN_pa). (AGN:NYSE) last quarter, with both parties agreeing that Allergan will not launch its generic Absorica formulation until Q4/20. Cipher's patent strength was strong, and did not expire until September 2021, but we believe giving away three quarters of branded exclusivity in exchange for making the uncertainty of generic launch timelines go away was a fair trade.

To give the market some credit on interpreting the Innocutis acquisition, for which we do have a positive view over a medium-to-long term time horizon, it is pretty clear that on a T12M basis, Innocutis was fully valued by Cipher even before considering the new interest expense Cipher incurred to fund it. Acquisition value was US$45.5M, ascribed to 2014 revenue of about CA$9.6M and an operating loss of CA$5.6M, and US$40M at 10.25% annual interest was required to fund the transaction. We get the market pessimism, but we see Innocutis more strategically because Innocutis' product portfolio contained multiple underpromoted dermatology products that are already generating greater revenue traction under Cipher's stewardship.

Products include the herpes/cold sore-targeted muco-adhesive acyclovir formulation Sitavig, which our analysis shows exhibited 113% sequential growth from Q3/15 (US$1.7M) to Q4/15 (US$3.6M; IMS Health data published by Bloomberg) with focused marketing initiatives from Cipher. Other core brands were correspondingly up in Q4/15, including the nail dystrophy drug Nuvail, which was up 57% sequentially (US$2.7M in Q4/15 versus US$1.7M in Q3/15) and the hyaluronic acid formulation Bionect, which was up 10% sequentially (US$1.41M in Q4/15 versus US$1.28M in Q3/15).

We believe that if Cipher's forthcoming quarters exhibit dermatology product sales growth as robust as Q4/15 seems poised to generate, the company is correspondingly poised for a valuation rebound, perhaps as early as H1/16. Despite Innocutis' negative EBITDA contribution, Cipher's financial data was still strong in Q3/15 in absolute terms, generating revenue/adjusted EBITDA/margin of US$8.5M/US$2.5M/30.1%. We have a Buy rating and a US$13.25/share price target on the stock.

TLSR: What about Merus Labs?

DL: Our investment thesis on Cipher's Canadian specialty pharmaceutical peer Merus Labs is a bit different, in that Merus has not established any specific medical markets that it intends to develop preferentially. But the company does seem to be focused on the more price-sensitive European market, where it opportunistically acquired regional marketing rights for Novartis' legacy urinary incontinence drug Emselex and small molecule anticoagulation drug Sintrom, among other agents in its product portfolio.

Merus' adjusted EBITDA margins have been sustainably above 44% since we initiated coverage in mid-2012, and while we do expect relative margin strength to continue-and while Merus does have $41M in cash to fund future pipeline acquisitions-we do see some revenue softness for Emselex, with pricing softness on lower reimbursement levels in its largest European market, Germany, likely to transpire as early as mid-2016, and with core patents expiring on this drug in August 2016, increasing the likelihood of generic competition on the horizon.

We like Merus' core business model of selectively acquiring stable pharmaceutical revenue streams in niche geographies, but efforts to augment the pipeline will need to accelerate so that pending revenue softness from Emselex can be offset by new revenue streams. Despite business risk on Emselex, Merus' financial data in Q4/15 was still strong, with adjusted revenue/adjusted EBITDA/margin of CA$21.4M/CA$9.3M/43.6%. We have a Buy rating and a CA$3/share price target on the stock.

TLSR: Please move on to Theratechnologies.

DL: Quebec-based Theratechnologies is in a slightly different specialty pharmaceutical category, not just because it is HIV-focused but also because, at least for now, it derives its market value from a single FDA-approved biologic branded as Egrifta.

This drug-and thus this stock-is emerging from a hugely challenging 2014, when Egrifta simultaneously experienced partnership and manufacturing challenges leading to product sales trending to nil just quarters ago. We upgraded this stock in October 14 after Egrifta manufacturing challenges had been partially resolved, and formal disengagement from U.S. partner Merck-Serono (a subsidiary of Merck (NS:MERK) KGaA [MKGAY:OTCPK]) had concluded. Egrifta sales have experienced a sustained quarterly revenue ramp-up, from CA$2.7M in Q4/14 to CA$4.6M in Q1/15 to CA$7M in Q2/15, and then to CA$9.2M in Q3/15.

We like Egrifta's growth trajectory long term, as Theratechnologies focuses more intently on promoting Egrifta's endocrinologic benefits in HIV markets, taking head-on the bias that its target indication, HIV lipodystrophy, is not as frequently misdiagnosed as we believe, and is not just a cosmetic disorder, while emphasizing the medical risks inherent in visceral adipose tissue deposition around abdominal organs and how this can lead to organ failure over time. Growth in international markets, mainly Latin America, is also an independent value driver in our model for this highly differentiated stock.

We suspect Theratechnologies will grow its pipeline in HIV markets beyond Egrifta, but our model makes no overt assumptions on timing or financial impact of future product acquisitions until we see what they are and how the capital structure needs to be modified to acquire them. We have a Buy rating and a $4.25/share price target on the stock.

TLSR: What about Neptune?

DL: Neptune Technologies & Bioressources is in a bucket all by itself in our coverage universe. This omega-3 nutritional supplement manufacturer/marketer is starting to recover from its tragic operational setback in late 2012, when its core omega-3 krill oil processing facility in southern Quebec was irreparably damaged in a facility explosion, requiring the company to manufacture a new facility on adjacent land. The new facility, for which construction was already underway back in 2011/12 to cater to growing omega-3 demand, still took considerably longer than we expected to complete. But the Sherbrooke-based facility is now functioning at full capacity of over 150 metric tonnes of annual krill oil production, for which we believe demand will grow correspondingly.
We came to our view that Neptune merited coverage through our original diligence on the medical benefits of omega-3 fatty acid supplementation. Despite consumer market skepticism, those benefits seem to be pervasive and well supported by clinical data, and we are separately positive about the superior bioavailability that phospholipid omega-3 formulations found in krill oil confer.

The firm owns half of the outstanding equity in a cardiovascular-focused spinout called Acasti Pharma Inc. (ACST:NASDAQ; APO:TSX). Clinical testing of Acasti's ultrahigh phospholipid-content krill oil formulation, CaPre, should commence patient enrollment in a U.S.-based bridging study imminently, and could correspondingly drive value in Neptune through achieving CaPre clinical milestones over the next few quarters.

Just as we saw in the case of Theratechnologies over the last four quarters, so too do we expect a sequential revenue ramp in Neptune's core krill oil operation now that manufacturing normalcy has been restored. On other initiatives, Neptune appears to be intent on vertically integrating its omega-3 franchise throughout the nutritional supplement value chain, and its first acquisition of substance was just consummated on Jan. 7, when it acquired Quebec-based marine oil producer and formulator Biodroga. This EBITDA-positive firm adds EBITDA at a time when Neptune can use EBITDA to support valuation while krill oil production ramps into 2016/17. The Biodroga acquisition is also strategically important for adding new distribution channels and new products to the portfolio, in what we hope are synergistic ways.

Neptune has a strong U.S. patent profile on medical uses and methods of production for omega-3-containing marine oil compositions. That the U.S. patent estate is strong is not just our opinion-it has been upheld on two separate reviews by the United States Patent and Trademark Office and should entitle Neptune to patent-based royalty revenue on global krill oil sales by its main peersEnzymotec Inc. (ENZY:NASDAQ) and Aker ASA (AKER:Oslo), though both protagonists continue to debate their economic obligations to Neptune through legal channels. All this should be resolved later in 2016; if in Neptune's favor, as we predict, this could be a key value driver independent of Neptune's core EBITDA generation. We have a Buy rating and a $4.50/share price target on the stock.

TLSR: Are there any other areas of interest in the Canadian biotech and pharma markets that investors should be aware of?

DL: Our coverage universe is both comprehensive and diversified across multiple healthcare silos, with emphasis on firms based in Canada and publicly traded on Canada-based exchanges. Though I will focus on drug development firms to cater to your readership, we accurately called strong returns in stocks residing outside of the drug development universe last year.

Strong performers included long-term care service provider Extendicare Inc. (EXE:TSX), which we have rated as a Buy. Since our upgrade in November 2014, the stock has generated relative return on share price appreciation alone of 43%, and if we add in cumulative dividend paid out during that time, total return is 48%. We predicted capital markets would respond favorably to reduced business risk from divesting the firm's U.S. nursing home operations and deploying capital into new Canadian eldercare assets, as the company started to do in H2/15. The firm's core operations and dividend yield stability continue to be strong.

Separately, one of our Top Picks for 2015 was a Quebec-based medical device sterilization technology developer called TSO3 Inc. (TOS:TSX; TSTIF:OTCPK). This stock generated total return last year of 38.5%, driven less by quarterly financial performance (EBITDA is still negative) than by tangible regulatory and business development milestones.

As background, TSO3 recently received FDA approval for a novel low-temperature sterilization platform called VP4, which uses a combination of ozone and hydrogen peroxide for sterilizing devices commonly used within hospitals prior to reuse, as opposed to chemically disinfecting the devices. This medical industry is not talked about often, and there are very few competitors worldwide- Steris Plc (STE:NYSE), Johnson & Johnson (N:JNJ:NYSE), 3M Healthcare (MMM:NYSE)and Getinge AB (GNGBF:OTC; GETI B:Stockholm) are the "Ford-Chrysler-GM-Toyota" of this industry. The competing sterilization equipment that each manufactures uses different technology based either on hydrogen peroxide only, or on ethylene oxide, or on steam-formaldehyde as alternative sterilant gases.

The advantage of TSO3's VP4, which is already recognized not just by FDA approval but also from an exclusive marketing alliance with Getinge AB, is that VP4 seems to have cost advantages over peer devices. It can sterilize more medical equipment per cycle, and it could be more effective at sterilizing complex devices like flexible duodenoscopes, which present unique geometric and anti-microbial challenges that VP4 seems to have overcome.

TSO3 has formally submitted documentation to the FDA seeking specific claims on flexible duodenoscope reprocessing. If granted, TSO3 would be differentiated among its peers on this capability, while simultaneously providing a true sterilization modality for duodenoscope reprocessing at a time when the association between the use of unsterilized scopes and GI infections is well recognized by both the FDA and scope manufacturers themselves.

We are getting strong signals from TSO3 and Getinge that early VP4 demand is strong; the firms are expanding manufacturing capacity earlier than previously expected. We expect tangible VP4 unit sales to drive valuation in 2016 and future periods. We have a Buy rating and a $3.10/share price target on TSO3, but with substantive upside if VP4 duodenoscope sterilization claims are recognized by FDA within the next quarter or two.

TLSR: Do you cover any companies working in medical devices?

DL: We have two other medical technology developers in our universe that bear scrutiny, one a fluorescence-based, real-time, surgical imaging platform developer called Novadaq Technologies Inc. (NVDQ:NASDAQ) and the other an implantable cardiovascular device developer Neovasc Inc. (NVCN: NASDAQ). Both are dual-listed in the U.S. and Canada, and both are well positioned to generate shareholder value in 2016 as they have in prior years.

Novadaq is developing SPY, an imaging platform that uses the intrinsic fluorescence intensity and albumin-binding capabilities of the dye indocyanine green (ICG) to assess tissue perfusion and define anatomic structures in ways relevant to disease diagnosis and treatment monitoring. Novadaq's original target market was coronary artery bypass grafting (CABG) surgery, using ICG fluorescence as a measure of saphenous graft patency post-CABG. While SPY was extraordinarily useful at assessing vascular outcomes post-CABG, it never generated much commercial traction in this surgical market for a host of reasons unrelated to device performance. More recently, the technology has been shown clinically to be highly useful in assessing viability of grafted tissues prior to plastic and reconstructive surgery procedures, notably in breast reconstruction after a partial or radical mastectomy.

It turns out SPY is highly useful at assessing perfusion within tissues to be grafted into the surgical site, and if identified to be well-perfused by SPY, vascular complication rates post-procedure decline to essentially nil in both practical experience and in assorted published studies. Novadaq has multiple surgical applications in which SPY imaging is shown to be useful and/or indispensible, including in colorectal resection surgery, where SPY imaging can assess colonic tissue perfusion post-procedure (nicely shown in the PILLAR II study), and in staging advanced cancers by identifying sentinel lymph nodes (SLN) through ICG uptake and imaging. Our channel checks indicate that oncologists are already positive about ICG imaging's utility in SLN identification, and a Novadaq-sponsored clinical study to specifically assess its merits in gynecologic cancers should commence shortly (the 150-patient FILM trial) and could generate FDA-approvable data in a year or so.

A larger, follow-on study to the PILLAR II study-PILLAR III-could generate data on colorectal resection patient outcomes in a year or so. But with SPY in its various incarnations-it is branded in specific medical markets as SPY Elite, PINPOINT, Firefly and LUNA-already approved in most major markets, Novadaq is valued as much on its current revenue trajectory as on future revenue upside that new clinical data could generate, so we are as focused on how sales perform now and in future years. The company just announced it generated 2015 revenue of around US$64M and thus exceed revenue guidance of US$62M, achieving 36.9% sequential revenue growth in the process, comparable to the growth rate implied by Novadaq's 2016 revenue guidance of US$84M-86M.

We are more cautious on near-term EBITDA because heightened marketing infrastructure build-out to support SPY Elite and LUNA commercial activities is expected to continue into H1/16 and probably will not impact top-line unit sales until H2/16 at the earliest. Based on that, it would not surprise us if Novadaq traded sideways for a quarter or two, until marketing expense ramp leads to direct unit sales augmentation. That aside, there is no shortage of quality clinical data supporting both SPY utility and SPY necessity in multiple surgical markets. We have a Buy rating and a US$16/share price target on the stock.

Moving to Neovasc, this Vancouver-based medtech firm is a technological leader in developing implantable, catheter-deployed cardiovascular devices. It has two leading technologies that have already generated positive human data and are well positioned to perform equally well in forthcoming pivotal investigational device exemption (IDE) studies.

The firm's lead value driver is probably Tiara, a transcatheter mitral valve replacement (TMVR) device targeting advanced mitral regurgitation. Early human feasibility data has been largely positive on both device performance and patient outcomes. Targeting mitral valve replacement with catheter-deployed alternatives has long been seen as an intractable engineering challenge, in part because the mitral valve has a D-shaped saddle-line geometry that needs to be replicated by devices and because hydrodynamic forces within the mitral valve are quite strong and likely to dislodge any valve prosthesis not well anchored.

Neovasc has shown, through Tiara's clinical performance, that engineering challenges have seemingly been overcome, at least in acute cases so far. We expect Neovasc to complete an ongoing feasibility study with about 30 patients over the next few quarters, and to advance into pivotal studies either next year or in 2018.

Neovasc has competitors, notably global valve giant Edwards Lifesciences Corp. (N:EW:NYSE),Medtronic Inc. (N:MDT:NYSE), and Abbott Laboratories (N:ABT:NYSE). All TMVR competitors either have devices in human studies or are about to. Neovasc's Tiara is advancing through human testing as fast, if not faster than its peers.

Neovasc's valuation, as driven by Tiara, has experienced some fluctuations in recent quarters despite strong Tiara development advances, in part, we suspect, because it is the one TMVR semi-pure play that has not been acquired by a larger peer, but also because it sustains added business risk not attributable to its peers through ongoing legal activities with Edwards, the outcome of which we hope to be clarified later in 2016.

Neovasc is also developing a separate technology-a novel stent called Reducer designed to deploy into the coronary sinus of chronic angina patients. This device performed extraordinarily well in the COSIRA trial, which we believe was sufficiently positive to justify advancing into pivotal IDE testing this year. Reducer has long been CE-marked in Europe, and commercial activities rolled out at a measured pace last year, with a sizable 400-patient observational study in Europe expected to commence shortly, and to facilitate Reducer's pace of adoption over time.

Neovasc's market value should be driven by future clinical trial outcomes for both Tiara and Reducer, and human data available so far predicts future pivotal studies could heighten medical prospects in the emerging TMVR market and in treating chronic refractory angina, respectively. We have a Buy rating and a CA$9.50/share price target on the stock.

TLSR: Do you have any parting advice for investors as we enter 2016?

DL: Sure. I selected the aforementioned stocks precisely because each has forthcoming milestones relevant to value creation this year. The U.S. initial public offering (IPO) market continues to be strong in early 2016, and while we cannot predict with certainty just how long that IPO window will stay open, we see IPO activity as a useful surrogate measure for overall sector attractiveness, notwithstanding the early choppiness we are seeing in valuations across all healthcare silos.

In a market where valuation trends appear to be directionless, we advise one of two strategies. One is to go defensive by deploying discretionary capital into dividend-yielding investments, a strategy for which Canadian healthcare provides a few but limited options beyond our eldercare stocks like Extendicare. Another is to go into stock-picking mode and deploy capital into clinically active drug/device developers for which value-creating inflection points are forthcoming.

TLSR: Thanks for your time, Doug.

Douglas Loe, healthcare equity analyst with Euro Pacific Canada, brings more than a decade of experience to financial analysis in the global drug development, medical technology, healthcare services and specialty pharmaceutical sectors. Loe has been recognized as one of Canada's top healthcare analysts by the StarMine Analysts Awards, based on the quality of his recommendations to institutional investors. With his extensive knowledge of the healthcare industry, Loe analyzes and publishes his views on trends in the sector and interprets them within the context of a diversified suite of companies under coverage, many of which locked in substantial returns for investors over the last several quarters. He holds a Ph.D. in biochemistry.

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