A Bit of an Update and Kindred Biosciences

In the month since I last wrote I have mostly stayed the course that I laid out in my last portfolio update.  I took a couple of small positions which I have subsequently sold (HyreCar, which worked out, Graftech International, which didn’t).  I sold out of Gran Colombia, Atlantic Gold and Golden Star Resources, all of which had risen quite a bit over the last 2 months.  I sold out of C21 Investments just this week.  And I also reduced my position in Liqtech as it has appreciated.

Add it all up and I have an even larger cash position now than I had in the fall.  I have only a couple of positions that are more than 1% in size.  I’m close to net short in my account after including index shorts.

My plan is to mostly wait patiently in cash.  I’ve said it before a few times: if the market keeps going up for reasons that I don’t really understand, I’m okay with it doing it without me.

But I’m still on the look out for stocks that aren’t too economically sensitive and offer some upside.

I thought I had found a decent one with Kindred Biosciences.  But my timing was horrible.

I got the idea from @FBuschek who pointed me to this podcast where former hedge fund manager Steve Kuhn says he has 10% of his portfolio in the stock.

I took a 1% position in the stock early this week.  Then the company released earnings last night and the stock tanked today, down 15% at one point.  I’ll get into why, but first a brief overview of the company.

Kindred has a market capitalization of $370 million (39 million shares) and $125 million of cash.  They are mostly a clinical stage biotech – they are only starting to generate revenue from one approved product (Mirataz) and are burning cash at about a rate of $45 million a year.

The twist is that Kindred Biosciences focuses on animal pharmaceuticals.  They develop drugs for companion animals, which means house pets like cats and dogs but also horses.

The high level idea here is that Kindred says they can be much more efficient with capital than your run of the mill biotech.  The line they use at conference calls is that the addressable market for an animal drug is typically one-tenth that of a human drug, but the costs of development are one one-hundredth.

It’s a compelling catch line and I think there is some truth to it, though it remains to be seen whether the incremental value of an animal drug is to the extent Kindred suggests.  After all, Kindred is spending enough on their operating expenses ($53 million in 2018 including $26 million on R&D) that it’s clearly not free.

The other twist on the business is that veterinarians that prescribe the drugs are generally also effectively the pharmacists.  They sell the drugs they prescribe.  So they  have an economic interest in prescribing new drugs that they can sell to their patients.

Kindred’s first drug, Mirataz, was approved last spring and started selling in the third quarter.  Sales in Q3 were $600,000 and that rose to $1.4 million in the fourth quarter.

Mirataz is for managing weight loss in cats.  Preventing weight loss in cats, particularly old one’s, is necessary. Cats that lose 10% of their weight are at significant risk of liver failure and death.  “If you’ve owned a cat, often at the end of their life, what happens is they get sick for some reason, they stop eating and they get sicker and sicker and sicker.”  The trick is to find a way to get them to eat again.

Mirataz is based on a human generic drug called mirtazapine.  The problem with using mirtazapine directly in cats is that its sold in pill form.  The cat owner has to break up the little pill into 8 and then manage to get the cat to swallow it.  Compliance is low.

Mirataz puts mirtazapine into a transdermal delivery system, which means its an ointment, this case applied inside the cats ear, that seeps in through the skin.  Compliance is expected to be much higher. Mirataz was approved by the FDA in May 2018.

It’s a legitimate use case and the transdermal delivery system makes a lot of sense.

Where will sales go?  Well here is where we get into today’s collapse.

There are 9 million cats in the United States with this problem.  3 million of them are being treated right now.  About half of those are considered chronic and will need treatment for months or years.  A tube of Mirataz goes for $15. That is a 2 week supply.  The veterinarians are expected to mark it up to $30.

The big opportunity with Mirataz is on the chronic side – if the 1.5 million chronic cases require 6 months of supply every year that’s an addressable market of $585 million.  That’s a pretty big TAM.   If the other 1.5 million cats being currently treated require a 2 week treatment that is $22.5 million. So the 2-week treatment is much smaller.  The 6 million cats that aren’t being treated are additional upside if the owners bring them in now that there is an option with better compliance.

Putting this all together, the TAM looks quite large.  But how accurate that TAM is and how it translates into revenue remains to be seen.  It’s early. What we are seeing today in the share price is a consequence of that uncertainty.

The stock is selling off today because Lake Street reduced their target significantly (from $30 to $12), on concerns that Mirataz revenue will be lower than modeled.

Kindred Biosciences price target lowered to $12 from $30 at Lake Street Lake Street analyst Brooks O’Neil lowered his price target for Kindred Biosciences to $12 following the company’s Q4 results while affirming a Buy rating on the shares. The analyst says that while Mirataz, Kindred’s first approved drug, is off to a solid start, he now believes revenue from the drug will be lower than modeled previously. However, the company has a “deep pipeline of attractive drug candidates for the large and growing companion animal medicines space,” O’Neil tells investors in a research note.

I don’t have access to Lake Streets research so I don’t know how much they reduced their sales estimate by.

Reading over the conference call it looks like this was probably the key exchange that led to their reduced expectations (my italics):

Brooks Gregory O’Neil, Lake Street Capital Markets, LLC, Research Division – Senior Research Analyst [43]

Sure. It makes sense. In the past, you guys have talked about 9 million cats having inappetence and big percentage, perhaps as many as 50%, being chronic. What have you seen in the U.S. market so far in that regard? And can you say if you see any big differences between the international opportunity for Mirataz and what you’re seeing domestically?

Denise M. Bevers, Kindred Biosciences, Inc. – Co-Founder, President, COO & Director [44]

Sure, Brooks. So again, I’ll just reiterate that our product is labeled for 2 weeks, and that’s what we’re marketing toward. The challenge we have, of course, as I’m sure you understand, is getting down to patient-level data. The way to do this is through market research. We have ongoing market research initiative. What we do know is that unintended weight loss impacts many chronic conditions, cancer, chronic kidney disease, hypothyroidism, diabetes. How the veterinarian chooses to use the product is obviously up to his or her clinical discretion. So we will continue to collect market research and report on that accordingly. As far as opportunity, as I said, it’s about 2/3 typically is about the opportunity in Europe versus the U.S. And we suspect that veterinarians will be treating the same host of cats with these conditions, chronic and acute.

I’m thinking that Lake Street took the response to mean that Kindred was backing off of their expectations for the chronic market.  Is it also noteworthy that Lake Street was not part of the last financing?

So I don’t know.  I was thinking Mirataz could do $50 million of revenue once sales matured.  Is that too high?  Reading through a couple of the analysts I have managed to get research from, I was seeing peak numbers around the $75 million range.  This was prior to today’s call though.   What’s realistic?  Tough to say.  There’s really not a lot of information to go on here, which I guess is the problem.

But I’m still pretty interested in the idea, which is why I didn’t just cut and run this morning (I did do a whole lot of waffling however).  The pipeline is big.  In addition to Mirataz, Kindred Biosciences expects 2 drug approvals and 3 more pivotal studies in 2019.

The nearest term opportunity is with a drug called Zimeta.  It controls fever in horses.  Kindred showed positive results in a pivotal study of 139 horses.  The FDA has done most of its due diligence and all that seems to be left is a last manufacturing inspection before it is approved.  The market for fever in horses isn’t huge, but it looks like the drug should be able to get $10-$20 million of revenue once it ramps up.

Kindred announced positive data on its pilot field effectiveness study for the drug epoCat in January.  epoCat is intended to control anemia in cats.  The results from the study looked to be very good (albeit to my untrained eye).  The next step is a more extensive pivotal study that will take place in 2019 with a read out either in late 2019 or early 2020.  If successful the drug could launch late in 2020.  Based on the analyst estimates I’ve seen the revenue from epoCat could be in the $75-$100 million range.

Stepping even further out Kindred has a couple of drug candidates for atopic dermatitis in dogs.  This is a big problem in dogs and there are already a few other drugs on the market.  There are two drugs sold (Apoquel and Cytopoint) by the very large animal health company Zoetis.  The market size of atopic dermatitis is $500 million plus and growing so there is a lot of opportunity.  It’s possible these candidates, if successful and if they prove more effective than the atopic dermatitis options available right now, the estimates I’ve seen suggest the revenue opportunity is over $100 million.

So there appears to be lots of ways for Kindred to win.  Nevertheless, getting smacked on my purchase only a couple days after I bought makes me wonder if there is too much I don’t know here.  One of the things Kindred has said themselves is that animal health is not very well followed or understood – the research on market potential and on chances of success are not as well defined as in human biosciences.  So we are all kind of flying in the dark.

Looking at the competitive landscape, these animal health companies get big multiples.  Zoetis trades at 8.1x EV/Sales.  Idexx Laboratories trades at 8x EV/Sales.  Elanco, which is not really growing, still trades at 4.3x EV/Sales.

So if I spit-ball it and say that Kindred should trade at 7x EV/sales, then the current stock level is pricing in about $50 million of sales (I’m ignoring the cash which I assume they’ll burn through to get there).  Sales at that level are probably 3-4 years out so maybe I am too optmistic.   But even so it doesn’t seem like a high bar to pass given the pipeline of opportunities they have.

But this is a case where I can truly say – but what do I know?  I’ll keep my position small and wait out more information.  We’ll see how the data comes out with Mirataz and I’ll maybe look at adding if it appears Lake Street is wrong and the chronic market for Mirataz is there.