Reminiscences of a Stockblogger

May 1

Week 354: Winners and Losers

Portfolio Performance

Thoughts and Review

My method of investing generates a lot of losers. I think it’s a pretty good bet that over 50% of the stocks I pick for my portfolio lose money.

My performance is generated primarily by a few winners that end up being big winners. When I went through a slump in late 2015 – early 2016 I pointed out how few multi-baggers I had. I was generating lots of losers of course, but I didn’t see that as a problem. The problem was that the winners weren’t winning enough. For my method to work, I need at least 2-3 stocks a year that go up 2-5 times.

The math on that works in my favor. If I have 2 stocks a year that make up 4% of my portfolio each (I usually start out at 2-3% positions but add as they go up) and they go up 3x then my portfolio gains 24% from those positions. If they double then I gain 16%. If I can manage the rest of the portfolio to limit the damage; sell the losers before they get too destructive and have a few other smaller wins to help offset the losses, then overall I’ll do okay.

Anyways, that’s my plan. Its why I invest in a lot of businesses with high upside but questionable paths to achieve that upside. I’m fine with those that don’t pan out, as long as a few of them do.

Since last summer my big(gish) winners (this is off the top of my head) were: Combimatrix, R1 RCM, Gran Colombia, Aveda Transportation, Vicor, Helios and Matheson and Overstock.

Combimatrix was taken over and ended up being between a 2-3 bagger. R1 RCM was a triple. Gran Colombia is almost a double so far from my original purchase at $1.40. Aveda Transportation got taken over a couple weeks ago and was nearly a double. Helios and Matheson was a little less than a triple (I sold out well before the top, in the $9-$10 range) and Overstock was about a 70% gain.

Both Helios and Matheson and Overstock turned out to be flops in the end, but that’s okay too. A big part of my strategy is to know what I’m getting into, and not fall in love with it because there is a good chance it ends up going south. In both those cases I was pretty cognizant of the company’s faults, and I freely admitted there was a lot of uncertainty with both. As the faults materialized, or as too much optimism was priced in, I reduced my position in each and eventually sold out.

Vicor Results

I had been going through a drought in the new year before I finally got the move I had been waiting years (literally years!) for with Vicor. Finally the rest of the tech-world is catching up with Vicor’s 48V converter technology. Applications are popping up all over. There are the 48V servers, which were the original reason I got into the stock, but also low voltage GPUs (from Nvidia and AMD) requiring power on package, new areas like electric vehicles and AI, and most recently the evolution of a reverse 12V to 48V datacenter application. All these customers seem willing to pay for Vicor’s superior and patented technology.

I looked at Vicor way back in March of last year and worked out the numbers on an optimistic trajectory for the company. At the time I pointed out that while the stock didn’t appear cheap on most metrics (it had no earnings and was at a fairly high P/S ratio given the lack of growth), if they could follow through on their growth plan, the earnings they could generate were pretty impressive.

I updated that model recently based on new projections and the fact that after the first $100 million of earnings Vicor is going to have to start paying taxes (they have about $34 million of valuation allowances right now).

It looks to me like a $450 million of revenue run rate gives Vicor about $2.10 EPS when fully taxed.

The first quarter numbers were strong. Bookings and backlog have been outgrowing revenue. Backlog grew 23% sequentially. Bookings grew 15% sequentially. Revenue grew 11% sequentially.

After the first quarter numbers its looking more like that first $450 million of revenue could happen sooner than you think. $450 million is roughly what Vicor can do in their current facility.

Vicor is expecting to double capacity with a second facility later this year. If you assume that Patrizio (Vicor’s CEO) hasn’t gone off the deep end and that they can fill that second facility, the earnings numbers get much higher. Given that right now they are growing at 10% sequentially and that is before the larger orders that are expected in the third quarter start hitting.

I am inclined to hold the stock with the view that we are just getting started.

What I did in the Last 5 weeks

As I said I will always have a lot of losers. An important part of the strategy is to sell that which I perceive as not working out.

In the last month I did more selling than buying. This is partly due to broken theses but also because I remain cautious about the market. But to be honest, this caution has hurt me more than it’s helped.

Much of my selling has been poorly timed. For example, I sold Largo Resources at 1.30, only a couple of days before the stock made a run up to $1.90. I’ve written about the Largo story before: Largo is a great theme play on vanadium but it has always been hard to make the stock look cheap by the numbers. That has nagged at me and it finally won out. I took a nice gain on Largo, having bought it at 80-90c, but it still hurt to watch the stock subsequently take off.

I also sold Aehr Test Systems shortly before it ran from $2.20 to $2.60. With Aehr I took a loss. I’m still not sure whether I did the right thing selling it. On the one hand it feels late in a semi-equipment cycle, and the company has had very few announcements of new contracts lately. On the other hand it appears their relationships with Intel and Apple are intact and so the next big deal could happen at any time. It’s a tough stock to judge.

I also had poor timing with Essential Energy, which I sold at 55c range after listening to their fourth quarter conference call. The call painted a depressing picture of drilling in Western Canada. I didn’t get the sense they had any pricing power and the year over year utilization rate appeared to be flat. Now maybe that has changed as oil has risen another $10 since I sold. As well, the lawsuit with Packers Plus is in appeal (so its still not settled), which means a takeover is unlikely. I decided to focus instead on US leaning servicing companies like Aveda Transportation (which subsequently got taken over for a double, though it was a modest position for me) and Cathedral Energy Services, which I continue to hold.

I had somewhat better timing with my exit of Sherritt International, as the stock sank after I sold. But even the jury is still out as the share price has come back with nickel skyrocketing.

I likewise sold my position in both Orocobre and Albemarle. This fits into the “loser thesis” even though I made small profit on Orocobre. My thesis was that the consensus for lithium had under-estimated demand and over-estimated supply. However, the more I’ve learned about the supply/demand dynamic the less sure I am. It’s not so much that I’m a believer in the coming lithium supply tsunami. It’s just that I’m unsure enough to not want to make the bet either way. I’ll revisit these names again, especially Orocobre, but I need to study lithium some more and make sure I’m not wrong about it.

I also exited my position in Foresight Autonomous. I mentioned the stock last month and its just not working. They are going to need capital at some point and the recent death that was at the hands of an autonomous car isn’t helping. But probably my biggest reason for the turnaround is that this just doesn’t seem like a good market to be holding many nano-caps in.

Finally I reduced my DropCar position (which is heavily in the red) by about 20%. I probably should have reduced this stock earlier, but it was a tiny position to begin with (~1%) and so I’ve been more willing than maybe I should have been to give it some leeway. I still think they could pull off some big growth but the revisions of their option strikes, the share offerings and the lack of news has worn me down. Being down 40% on the position means at this point it so small that its a bit of a lottery ticket. Which is really what it always was.

Gold and Oil

What’s been working for me are my gold and energy stocks. Those that follow the blog know that I’ve been holding a number of gold and energy stocks for months now and that number has been increasing. Up until recently they have done nothing.

I wrote up my reasons for owning Golden Star Resources a few weeks ago.

I also continue to hold Gran Colombia Gold. I admit that I am a little nervous about selling pressure in the near term. I don’t totally understand what the short term outcome of the 2018 debenture conversions will be and whether sellers of those debentures will pressure the stock over the next while. Nevertheless, I think the company is on track for a re-rating at some point and I’m happy to wait out the weakness.

I also have positions in Jaguar Mining, RoxGold and Wesdome.

The idea with these stocks isn’t really about gold prices. I don’t feel like I am making a bet on whether gold will imminently go through the roof. I feel like I’m just buying stocks that are really cheap.

All the miners I mentioned above have EV/EBITDA ratio of between 2x and 5x. Those multiples are trailing ratios that are based on lower gold prices then what we have now. Each of the miners has good growth prospects and an exploration upside if drilling comes up positive. Apart from Gran Colombia, they are all well off their 52 weeks highs.

I also recently took a small position in Asanko Gold. The stock has been written up a number of times on the IKN blog. Gold Fields recently did a deal with Asanko, taking 50% of their property in return for enough cash to pay out their debt. Otto Rock, who writes on IKN, thinks Asanko should trade back to at least 1x book value now that Gold Fields is available to provide their expertise and hopefully right the ship at the Asanko Gold mine.

So if the gold price breaks out, that’s an added bonus. But these stocks are more of a play on sentiment. I think all I really need on the commodity side is for gold not to crash.

I don’t really have a crystal ball with what gold will do. I will note that the chorus of the gold bears on twitter seems very loud right now. “It didn’t go up with North Korea”, “It can’t break $1,360”, “It’s setting up a technically bearish formation (a compound fulcrum top?)”, “The Australian dollar, the Canadian dollar are canaries in the coal mine that the rally isn’t real”, and so on.

Who knows? Maybe they will be right this time.

I have been reading about the 70s, and in particular what Nixon did that led up to the Smithsonian agreement. The circumstances today are different of course, but not so different, and I was surprised how much of what Nixon did rang true to what Trump is doing now.

Nevertheless, I own tiny companies that are not in the GDX or GDXJ, typically don’t follow gold prices all that closely (Golden Star went down nearly 40% during the last gold rally!), and have unique attributes that I believe will lead to price appreciation. Gran Colombia, which is up 90% since I bought it last summer, is the poster child for this.

On the oil side I have all my old names: Gear Energy, Spartan Oil and Gas (which got taken over so now I effectively hold Vermillion shares), Zargon Oil and Gas, and InPlay Oil and Gas. I also bought WhiteCap as another way to play the run.

On the US side I continue to hold SilverBow and Blue Ridge Mountain. I also added Extraction Oil and Gas, which looks to be generating a lot of free cash in the coming years at these prices. I’ll write something up on them shortly.

The summary of what I have read on oil is that things are potentially tighter than we realize, that they are getting tighter, and that relying on a small patch of west Texas to supply the world’s growth is likely not the best strategy.

I’ve been surprised by the strength in the oil stocks. They seem to go up every day, and a lot of days they start down big and recover throughout the day. It’s hard to see that as bearish. I’ve read about the big net long positions, and I suppose that means we get a correction here at some point soon. But I’ve held these stocks for this long, I might as well see it through.

New Purchase: Ideal Power

The one stock I bought that I will mention in some detail is Ideal Power. This is the perfect example of a high risk, tiny little micro-cap that has a chance (maybe not a big chance but a chance) of being a 5-10 bagger.

Ideal Power sells inverters into the solar industry. One of their inverter products, called the Sundial, has been built into a Flex solar plus storage offering called NX Flow. NX Flow, interestingly enough, uses a vanadium battery.

Flex initially had huge expectations for NX Flow. Leading up to the product launch in December, Flex was saying they could sell 15MW per week of their product.

Now if you do the math on 15 MW per week, considering that Ideal Power sells their Sundial for about $10,000 per unit, that there is one Sundial per 30 KW capacity, you get a very, very big revenue number.

The reason the stock is at a buck and change is that those sales forecasts haven’t materialized. Maybe they never will. Flex is trying to “educate” their customers on the vanadium battery. The real benefit of a vanadium battery compared to its lithium-ion competitor is that the vanadium battery doesn’t degrade over time. The life span can be significantly longer and performance doesn’t suffer. The problem is that customers are used to buying a battery strictly on a per MW basis. On that metric alone the vanadium alternative appears more expensive.

Nevertheless Flex is a big company and I don’t believe they just pulled these numbers out of their ass. I feel like it’s worth a bet that the NX Flow begins to get some traction.

The stock has one other lottery ticket in its back pocket. Ideal Power has developed an alternative switch for converting between DC and AC power called a B-Tran device. Pretty much every inverter out there has some combination of IGBTs, MOSFETs and diodes that let you switch power back and forth from AC to DC and vice versa. The B-Tran can do this too, and it can do it while reducing losses to 1/10^th of what an existing IGBT solution will have. The double-sided nature of the device means that you can replace two IGBT’s or MOSFETs, and two diodes with a single B-Tran. So there is a cost savings.

The company just finished prototyping the device using their anticipated manufacturing process and it appears to work as advertised. The power semi-conductor market is $10 billion and the company has said that if all goes well B-Tran could address 50% of that.

Look I have no idea if this concept flies. It seems to have some merit based on what I’ve read from various electrical sites and papers but its very technical, there is incumbency at play, lots of factors will determine the success. My main point is if you are going to throw a hail Mary you might as well go for the end zone and that is exactly what this is.

The stock has a $20 million market cap and $12 million of cash, which they are burning as we speak. I could easily see myself selling this stock at 80c in 6 months time. In fact, that’s probably the base case. But the bull case is so big that I believe its worth the risk.

Portfolio Composition

Click here for the last five weeks of trades.

Apr 15

9 Comments

Golden Star Resources: Betting against a history of disappointment

I have been slow getting to this write-up. My plan was to write about how Golden Star had drilled a number of holes that extended the depth of their Wassa underground by 180 meters, that this would add a lot of resource to the mine, and that it was not priced into the stock.

But Golden Star beat me to the punch with this news release Friday. The company announced that they had doubled the inferred resource at Wassa, adding 3.1 million ounces for a total of 5.2 million ounces.

The next step will be further infill drilling to upgrade the resource to measured and indicated, and a preliminary economic assessment of the extensions.

So that took some of the wind out of my sails. The near-term story I was going to tell was kind-of squashed. Nevertheless the big picture story is by no means finished. In fact I think Golden Star is just getting started along a path to credibility. I’m hopeful that the destination is growth, and a valuation in-line with other gold stocks.

History of Disappointment

Golden Star Resources has always been a very cheap gold stock. The problem has been that this was well-deserved.

I’ve watched the company on and off for years. They have always been one of the highest cost producers. Cash costs typically exceeded $1,000/oz. This is what cash costs and all-in-sustaining costs (AISC) looked like from 2013 to 2015:

These kind of numbers made them bottom quartile in costs.

But that’s changing. In the last two years Golden Star has gotten their costs down. With the transition to underground operations at both of their mines (Wassa and Prestea), costs are expected to come down even more. ASIC in 2018 are expected to be between $850-$950/oz:

These new numbers don’t put Golden Star in the high cost bracket any more. They are in line with the majority of producers. Here is a brief list of other companies where estimates range from $850-$950/oz AISC or higher for 2018: Acacia Mining, Argonaut Gold , Detour Gold, Eldorado, IAMGold, Kirkland Lake, Klondex, Lea Gold, New Gold, OceanaGold, SEMAFO, Teranaga Gold, … you get the picture.

While costs are trending towards the average, the valuation has not. Golden Star trades at less than half the price to cash flow multiple as these other names. If you start to factor in the potential growth it looks even cheaper.

So why the disconnect?

I think its just years of disappointment. The market needs a lot of proof before they will re-rate the company.

Wassa and Prestea Underground

The bet here is that things are changing. Golden Star has two underground mines that are ramping up, a tonne of exploration prospects both within these mines and in the surrounding land base, and the capacity to grow production within their existing asset base using little additional capital.

Golden Star operates two mine complexes, Wassa and Prestea.

Both of these mines started off mainly mining open pit ore but are transitioning to underground. Wassa is ahead of Prestea, having begun underground production in early 2017. Wassa has been ramping up since and is performing well.

I think that one of the problems Golden Star has had is that reserves for both Wassa and Prestea underground are limited. Mineral reserves for Wassa are 742,000 ounces which they say is about a 5 year mine life. Similarly Prestea has reserves 463,000 ounces, which works out to a 5.5 year mine life.

I’m not sure why the reserves at these mines is so limited. Some of it is that underground mines often have smaller resources because drilling out too far ahead of the mining activities is expensive. Golden Star has been hanging on by a thread for years, so these were likely costs they chose to to incur. I also get the impression that there have been stability issues at Prestea that have only recently been corrected and allowed more drilling to take place.

While reserves are small, there is a much larger inferred resource for both mines. With Friday’s press release, the Wassa inferred resource is up to 5.5 million ounces. Prestea has 800,000 of measured and indicated and 868,000 ounces of inferred.

The small reserves and large inferred resource present an opportunity.

When you look at analyst estimates they, quite rightly, are basing their net asset value calculations primarily on known feasibility studies and preliminary economic assessments.

Take BMO for instance. They have an NAV5 for Golden Star of $1.04.

I can reverse engineer that number (like I’ve done below). To do so, I back-out total production from Wassa of a little over 1,000,000 ounces and 471,000 from Prestea (both the NAV0 and NAV5 match reasonably well, so I think I’m on the right track with these numbers).

Wassa has 5,000,000 inferred ounces. Prestea has 1,600,000 measured, indicated and inferred ounces. Very few (in the case of Wassa) to none (in the case of Prestea) of these ounces are included in the net asset value. The inclusion of these ounces, if the company can successfully prove them up, represents a lot of upside for the stock.

What’s more is that Golden Star can add significant production within its existing mining infrastructure. They have built their mine and milling capacity with expansion in mind. The mine at Wassa has capacity for 4,000 tpd while the mill can handle up to 7,000 tpd. At Prestea its even higher, with the mine at 1,500 tpd and the mill at 4,000 tpd.

Wassa could easily expand its mine rate by 30% before having to expand the shaft and decline. Prestea could more than double production before having to do so.

What this means is that if Golden Star is successful in turning inferred ounces into reserves, the cost of bringing those into production will be minimal. They should be able to ramp to double their current production without having to put out a lot of capital.

First Quarter Results

Golden Star provided first quarter production numbers on Wednesday night. Wassa exceeded the expectations of most analysts, producing 35,506 ounces at 4.54g/t grade. Grade had been an issue during the ramp of the underground at Wassa. In the third quarter grade averaged 2.6g/t, well below the 4g/t feasibility grade. The fourth quarter improvement to 4.04g/t, followed by this latest news is evidence that Wassa is on track.

The Prestea underground is earlier in the ramp. The mine just reached commercial production (defined as 60% of capacity) in February. They are having problems typical to a new start. In the first quarter they were only producing from a single stope, and the models of that stope were a little off the mark, which led to more dilution (lower grade). They say they’ve reviewed the stope model, figured out what was wrong with it, and expect better grades when they start mining a second stope in mid-April.

The second and third quarter numbers will have to be watched carefully for progress from Prestea.

Exploration

Apart from getting Prestea up to plan, the big news will be exploration results. The company is spending $6.6 million in 2018, split between Wassa, Prestea and new targets around the Prestea and Wassa complexes.

The drilling at Wassa will be focused on filling in the areas between existing drill holes. In the section below the pink area represents the original 2,000,000 ounce inferred resource. The step out to 18900N is where they drilled the extension that added another 3,000,000 ounces. You can see the large gaps that need to be filled to clean up the resource. Doing so will upgrade the inferred resource to measured and indicated and to reserves.

To facilitate drilling they have created an exploration drift extending from the mine to facilitate the drilling. I believe this is the line extending from the mine to the north just above the pink inferred resource box in the map above. Therefore the drilling meters planned at Wassa are a little deceiving, because they can drill a lot more holes from closer to the ore from this drift, so I expect them to accomplish a lot in those 11,000m they have planned.

The opportunity at Prestea is a little less clear. Prestea is about a year behind and so the company is just now starting to evaluate how they might expand production in the coming years. Drilling this year will infill the existing inferred resource and more importantly focus down plunge on the West Reef (the green lines are the drill holes). Good results there will add new resource that could expand operations at the mine. Prestea is very high grade (14g/t or so) and the mill only operates at 600 tpd, so it doesn’t take a lot of new ore to add significantly to the mine.

There are a few other exploration prospects that Golden Star will spend about $1.4 million on in 2018:

All of these are quite early stage and I don’t know much about them yet. The most advanced appear to be Father Brown and Subriso West, which have a combined inferred resource of 476,000 ounces. Father Brown has an underground grade of 6g/t which sounds promising.

Conclusion

Friday’s price action not withstanding, I’m not expecting an overnight success with Golden Star. It is more likely to be months of positive results that slowly build back the company’s reputation.

But I think that the outcome will be worth it. Especially if gold prices can stick to the current $1,300 level or move higher.

The BMO estimate I pointed to has an NPV5 of $1.04 USD on the stock. Even after Friday’s move, that’s a significant discount to the current price of 66c. That estimate is done at 2018 gold averaging $1,280, dropping to $1,200 in the long term. It includes minimal tonnage from Wassa and Prestea exploration. It includes no ramp of production to 4,000 tpd at Wassa or 1,500 tpd at Prestea. So there are lots of ways that number can move higher.

It’s a simple play. Cheap on comps, cheap on net asset value, a good chance to ramp significant growth over the next couple of years, and in a commodity environment that, in my opinion, is more likely to go up than down.

Apr 5

8 Comments

Sonoma Pharmaceuticals: A Simple Bet on Rising Revenues

Note: I wrote this post up a few days ago but kept postponing the final edit. In the mean time this news came out (this morning). I haven’t really dug into it yet, I’m not entirely sure if this is a brand new product or a gel reformulation of their existing scar treatment product. But anyways, its constructive to the story as they added another product for their sales team to sell.

On to the post.

I’ve had Sonoma Pharmaceuticals on my watchlist for a couple of years now. I hadn’t paid it much attention, but I saw a couple of articles about the stock on Seeking Alpha over the last 6 months (here and here) and they kept me watching the stock. They were interesting, but not compelling enough to buy.

More recently when I saw that Daniel Ward had been accumulating a large position I got more interested.

Still I waited. I saw the company was short of cash and there would probably be a raise coming sooner or later. When that day came, I took a position.

Capitalization

After the capital raise Sonoma has about 6 million shares outstanding. At $4 that gives the company a market capitalization of $24 million.

There are a bunch of warrants and options outstanding but they are well out of the money. There are 1.3 million warrants priced at between $5 and $6.50. There are another 1.4 million stock options priced on average at $12.

The company has no debt and after the recent share offering closes they should have about $13 million of cash.

Burning Cash

Sonoma is not a profitable company yet. They burn cash. They are using about $2.3 million of cash each quarter. With the recent raise they would have enough to get them through 5-6 quarters at the current burn rate.

I think they are going to start using less cash as time goes on. The company has been growing its dermatology revenues like a weed. If this continues then they should close the gap to break even over the next 18-24 months.

Hidden Growth

Sonoma operates 3 segments. Only one of these segments is growing quickly. The growth is hidden by the other two slower growing segments, and by poor comps created by the prior sale of other businesses.

In October 2016 Sonoma sold its Latin American business for $19.5 million. The business made up 30% of revenue at the time.

As part of the agreement, Sonoma agreed to continue manufacturing the products sold until Invekra S.A.P.I. de C.V. of Mexico establishes their own facility. Gross margins on this manufacturing business are only about 6%.

The consequence has been a double whammy. The revenue comps have looked bad because of the revenue loss. And margins looks bad because of the manufacturing agreement.

They also have a lower margin, low growth international business. They sell both dermatology and animal health products through this segment.

To be honest, there isn’t a lot of information on the international business. I know that in general they sell their derm products abroad and the list of countries is long, but I haven’t been able to pin down where sales come from and which products are the drivers.

The international business is expected to grow modestly going forward, in the 5-10% range.

The High Growth US Dermatology Business

Sonoma sells 6 products in its US dermatology segment. The four established products (Ceramax, Mondoxyne, Celacyn and Alevicyn) have shown significant sales growth over the last couple of years.

Overall U.S dermatology has been growing like crazy. Year over year gross revenue (before returns and rebates) was close to 100% in the fourth quarter.

The growth has been due to both price increases and script increases. Below is script growth for each of the 6 products over the last few years.

I’m going to dig in a bit further to each of these products next.

Celacyn

This is a prescription hypochlorous acid-based scar management gel. It softens, flattens and reduces the redness of scars.

Sonoma launched Celacyn in the fall of 2014. There are only two prescription scar treatments on the market. The other product is RECEDO. Sonoma estimates that the market share is about 60/40 in favor of RECEDO right now.

The company has talked about how the scar market is a big market. While I couldn’t find a number for the total addressable market (TAM) applicable to Celacyn, the global scar market is extremely large, at $16 billion and growing at a 10% annual rate.

I also found a quote from the company saying that the addressable market for Celacyn is “62 million scars formed annually”. So the TAM is big.

According to this paper, the scar management market is seeing acquisitions. In March 2017, Hologic Inc., announced the acquisition of Cynosure Inc., to expands its business in medical aesthetic market. The acquisition was at 3.3x sales.

Prescriptions of Celacyn were pretty flat last year. But the company has been putting through price increases which has brought sales up. Based on company data (which I believe comes from teh Symphony database) the average price per script was $200 in Q4 2017 vs $133 in Q4 2016 and $102 in Q1 2016.

According to this blog post, which admittedly is a couple of years old, Celacyn at the time was “the low cost provider compared to competing products sold for wholesale acquisition cost (WAC), or the price paid by the wholesalers, in excess of $200 and ranging up to $800.” Just from a few Google searches, it looks like RECEDO retails right now at $314 per bottle.

So I’m going to say the move to $200 per script is just catching up and the company has saw better leverage to price then volume over the past couple of years.

Ceramax

Ceramax manages skin irrations, rashes, and inflammation. It is FDA approved as a “skin barrier repair product” for eczema and atopic dermatitis.

Sonoma launched Ceramax in May 2016. It was an acquired drug (US License) from the Lipogrid Company of Sweden.

Sales have had a bit of an uneven trajectory. Scripts jumped from 1,908 to 2,382 yoy in the fourth quarter. But in the third quarter sales were down year over year, from 1,410, to 2,12. Still its a new product, and the trend is clearly up.

There has also been price increases. When they launched in the second quarter of 2016 Ceramax, the average price was $225 per script. That has increased to $314 per script in the fourth quarter.

Sonoma seems pretty optimistic about the outlook for Ceramax. In the last call they said:

Ceramax was our fastest seller in December due to several factors. First, Ceramax has the highest concentration of ceramides, fatty acids and cholesterol that our skin craves, on the market today. Second, everyday dermatologists see patients with inflammatory skin diseases and every inflammatory skin disease patient has disrupted skin barrier in some way, shape or form. We think the sky is the limit with this product. Third, we have a great rebate program for Ceramax, meaning, we go out of our way to make it affordable to every patient. And then finally, the winter months in North America bring on winter itch and Ceramax has great clinicals in addressing itch.

To some degree its a seasonal product, so we should expect sales to trend down in the first quarter.

Its tough to get an exact figure on the market size because all the reports are expensive and I’m not paying $4,000, but its easy to glean that ballpark, its a big market. According to one older study I found, globally the market is around $800 million with the US accounting for $600 million of that market. I’ve seen estimates suggesting it could grow to over $2 billion by 2021.

Mondoxyne

Mondoxyne is a prescription oral tetracycline antibiotic used for the treatment of certain bacterial infections, including acne. It works by slowing the growth of bacteria which helps the immune system catch up. The sell it in 50mg, 75mg and 100mg bottles.

Mondoxyne is a cheap alternative to other brands. This post says that Mondoxyne is similarly priced to generics and far below branded products.

Sonoma acquired Mondoxyne in 2015. Since that time they have had a lot of success growing the brand.

Quarterly scripts have increased from 222 in the first quarter of 2016 to 1,733 in the fourth quarter last year. Price growth has been very modest, and prices actually appear to have declined from $595 to $459 sequentially in the fourth quarter. I’m guessing this would be due to mix, selling more 50mg bottles?

Alevicyn

Alevicyn is a prescription hypochlorous acid based atopic dermatitis product line. It reduces itch and pain associated with various skin conditions.

Alevicyn is the their largest revenue product. Revenue was up from $1.1 million to $1.6 million year over year in the fourth quarter, or about 50% growth.

The growth is coming from unit growth, up 17% year over year in Q4, from 4,204 to 4,930, and from price increases. Using Sonoma’s data I estimate that the price per script was $100 in Q2 2016, rising to $150 in Q4 2016 and to $200 in Q4 2017.

Much like Celacyn it appears that the price increases are just catching up to the competition. On the August 2017 call the company said:

“Our price per gram of product is currently well below that of our competitors. For example, Topicort, a solid branded mid-potency topical steroid for the treatment of atopic dermatitis, sells for $4.50 per gram; a comparable generic sells for $2.67 per gram; and our Alevicyn gel sells for $1.11 per gram”

In many cases Alevicyn competes against corticosteroids that go for $100 to $800 per script.

In November and December, the FDA approved expanded antimicrobial language for Alevicyn.

According to this report from Stonegate capital, the addressable market for Alevicyn is between $500-$600 million.

Sebuderm

Sebuderm is a prescription topical gel used as an alternative to corticosteroids for the management of the burning, itching and scaling experienced with seborrhea and seborrheic dermatitis.

Sebuderm was launched just over a year ago and scripts have been growing significantly. In the fourth quarter scripts were 1,206 up from 948 the prior quarter.

There is not a lot on the size of the market, but Sonoma did say that “25% of the general population has seborrheic dermatitis” earlier this year.

Worth noting is that in the same press release Sonoma commented on the products efficacy. They announced the results of a study that showed an improvement in appearance and symptoms “from baseline was 33% at day 14 and 52% at day 28…[and] 62% through day 28.”

Loyon

Loyon is a prescription liquid for managing erythema, itching for seborrhea and for seborrheic dermatitis. They have some pictures in their last presentation showing Loyon being used on peeling skin around the hairline, where it clears it up after about 7 days.

Loyon is the most recent launch. It was launched in September after receiving FDA approval in March.

Loyon can also be used for psoriasis but it isn’t approved yet. They are in the queue requesting approval from the FDA. On the last call they said:

In Europe, it’s currently being sold in Germany and the U.K. for broader indications than we got in the U.S. to start. They have a psoriasis indication in Germany and the U.K. We took their clinical data, got back into the FDA queue and it is very, very compelling clinical data. So we have our fingers crossed that we’ll get that. Bob, are we saying within the next 12 months?

Loyon is already widely used in Europe. They bought the US license for the product from a German company. On the fiscal second quarter call they said that European sales (in Germany in the U.K) are about $10 million. In Europe Loyon is approved for psoriasis. In the US its competing against two older legacy products.

Breakeven

Sonoma does better than average job of explaining what it will take for the company to reach break even. On slide 25 of their February slide deck, they show where they are now on a per salesperson basis and where they need to get to in order to break even.

Increasing the number of prescriptions per sales rep is not as daunting as it appears. Last May CFO Robert Miller said that the more experienced 17 sales reps that had been with company 1-2.5 years did around 815 scripts per quarter.

With new products and extensions added since that time, getting all 30 reps up to 900 scripts per quarter should be an achievable task. At least that’s what I’m betting.

To help growth they have been trying to add a new product or line extensions every six months. In the fourth quarter of 2017 they launched Loyon. In early 2018 they have new line extensions for Ceramax.

The rest of the increase is going to come from price increases and mix improvements. From the above table it looks like Sonoma is betting they can raise the average net per script about 30% from the last quarter’s average.

I’m less certain about how easily they can do this. There is evidence anecdotally that many of their products are cheap compared to the competition. But I have a difficult time knowing when they hit the ceiling on price increases.

Sonoma also provides a detailed rundown of what it will take for company wide break even on the following slide of their presentation.

The key number is the $4.158 million of net revenue. Sonoma grew the US dermatology segment at 78% year over year last quarter. The quarter before that was 53%, and before that was 74%.

Presumably they are going to see growth slow as the initial ramp from the new reps begins to level off. Nevertheless, I am willing to bet they can reach breakeven in about 8 quarters. That would require year over year growth of net revenue from dermatology (assuming no growth outside of derm) of 40% on average.

Conclusion

With a market capitalization of $24 million, cash of $13 million and their derm segment growing at 50-70% I am betting Sonoma has bottomed.

I think that we are inflecting to where derm is big enough to overwhelm the lower growth segments. And where the market starts focusing on this growth more than the cash drain.

I’m also betting that as the company gets closer to break-even, they can get revalued more conventionally on a revenue multiple.

I mentioned above this research paper, which noted that scar management “has been experiencing a number of acquisitions and collaborations”. They point to the acquisition of Cynosure by Hologic, which was acquired at an enterprise value of $1.4 billion, net of cash. This works out to 3.3x sales.

Sonoma trades at 0.6x revenue including cash. Looking at some similarly sized competitors, Novabay Pharmaceuticals trades at 3.3x revenue and grew revenue of their only product, Avenova, at 50% year over year.

Novabay used $3.3 million in the first 9 months of the year.

Novabay seems like a particularly good comparison because the stock moved from $2 to $4 as the company demonstrated growth and began to close the gap to break even. I think Sonoma is in a similar spot to that now.

I have owned Novabay in the past and followed the company for a couple of years now. Using that experience as a roadmap, the trajectory for Sonoma is going to entirely depend on quarterly revenues going forward. If the company can maintain its growth momentum the stock price should do well.

Even tiny competitor Wound Management, which grew revenues 14% year over year in 2017, trades at 1.2x sales.

It will help that analyst estimates for the company are not that aggressive. Revenue for next year is expected to come in at $19 million which is less than 10% overall growth.

For the next quarter (fiscal Q4) the average estimate is $4.49 million. The fiscal fourth quarter is always seasonally down from the previous quarter. Backing out the derm numbers from the first quarter forevast implies expectations of about $1.7 million from dermatology sales. This would be a 41% year over year increase and a 40% sequential decrease.

This doesn’t seem like a high hurdle.

Bottomline Sonoma is a pretty simple bet. Beaten down and bottomed out. Continue the sales momentum and bridge the gap to breakeven. Hopefully if that happens the stock gets revalued closer to 3x revenue.

Mar 24

18 Comments

Week 349: Company updates, a couple new positions but mostly sitting pat

Portfolio Performance

Thoughts and Review

I’ve been slow on the updates. This is the second time in a row that its been 8 weeks between them.

I’m slow because my portfolio has been slow. I still have a high cash level. I took advantage of the stock decline in February, but not enough to have much of an impact on my results. Since then I sold down a few positions and so I’m back to a high cash level.

Portfolio Additions

I’ve already written about my new positions in DropCar and Precision Therapeutics, as well as reestablishing a position in Radcom and Silicom.

In addition I took a position in Sonoma Pharmaceuticals and Foresight Autonomous.

I’ve got something written up about Sonoma that I will put out in a couple of days, so I’m not going to talk about them right now.

Foresight Autonomous

My position in Foresight Autonomous is small (less than 1%), so I’ll just mention the thesis briefly.

The company is developing automobile detection systems (called advanced driver automation systems or ADAS). They have had successful trials with Uniti Sweden, and three successful pilots with Chinese companies.

The stock trades at a $110 million market capitalization. That’s not really cheap but I think the potential here is significant if they can land a deal with a large car companies.

Foresight also has a 35% interest in Rail Vision. Rail Vision provides detection systems for rail systems. Rail Vision was looking to IPO last fall at a $100 million valuation.

Worth noting is that this article said that Foresight’s technology has tested better than Mobileye. Mobileye was bought out for $15 billion.

Good News from existing positions

While my portfolio has only benefited at the margins, there were a number of positive news events over the last couple of months that do bode well for the stocks I own.

Vicor gave a very positive outlook on their fourth quarter conference call. They are making progress on the 48V servers, automotive and high end power on package applications. It seems very likely that they are working with a large FPGA producer (maybe Nvidia?) for high end power converters on the the chips.

Gran Colombia is doing very well at both of their mines. They provided a February update on Tuesday. They are on track to do more than 200,000 ounces if they can keep up the mining rate from the first two months of the year.

The next day the company amended terms to the debt exchange deal. The 2018 debentures will be redeemed, not refinanced. It means more shares and less debt.

The amendment doesn’t change my opinion on the stock. With the new terms they will have about $95 million of debt and 54 million shares outstanding. It doesn’t really impact the enterprise value much, with less debt there is somewhat less leverage to the price of gold but also less interest charges.

DropCar announced they are going to be doing maintenance and cleaning on the Zipcar fleet (transport,prep, cleaning, maintenance) in New York City.

The stock only moved a little on the news but it seems pretty significant to me. Zip Car has 3,000 cars in NYC according to their website.

While I’m not sure how b2b revenues on a per car basis compare to the consumer business, 3,000 cars is a lot of cars. Compare this to the 1,500 consumer clients they have right now.

The only question is what sort of revenues do they get on a per car basis for the B2B business? I need a bit more detail from the company on this. I suspect there are a lot of investors feeling the same way.

I wasn’t thrilled to see the $6 million private placement. It conveniently gets Alpha Capital Anstalt their position back without breaching the 10% rule (its a convertible preferred sale). But I still think the business could have legs. The recent Zipcar deal suggests that is the case. So I’ll hold on.

Precision Therapeutics (formerly Skyline Medical) has been announcing all sorts of news with respect to its Helomics joint venture.

I honestly don’t know what to make of this. I bought the stock because it looked like Streamway sales were going to launch, but all the news is about precision medicine, which is maybe (??) a bigger deal, but I don’t really know.

Some have pointed to Helomics revenue being in the $8 million range (which I’m not sure if it is), and that Helomics has spent over $50 million in research over the past 5 years (which appears to be the case based on the past capital raises). If either of these points are accurate then Helomics is potentially more valuable than the single digit million valuation that Precision paid for the first 25%.

But I’m not going to lie, I don’t really understand the precision medicine area very well.

If anything, the company seems to be prioritizing the precision medicine business and I would think, given that the Streamway business is not profitable, that would put Streamway on the block. If I’m right about the value in Streamway, then my original reason for buying the stock will work out, and maybe even sooner than I had hoped.

R1 RCM reported fourth quarter results at the beginning of March. They see revenue at $850-$900 million in 2018 versus $375 million of revenue in 2017. They are expecting adjusted EBITDA of $50-$55 million this coming year.

EBITDA is going to be depressed by the continuing onboarding of Ascension, new customers Intermountain Health and Presence Health, and the Intermedix acquisition.

In 2020 once the onboarding of Ascension is complete the company expects $200 million to $250 million of EBITDA. At $7.70, which is after the big move over the last month, that puts them at a little under 7x EBITDA. That’s still not super expensive and the path to get there seems straightforward so I’m holding on for now.

Gold stocks suck right now but I am adding. In addition to Gran Colombia, I’ve added positions in Roxgold and Golden Star Resources this week. Neither is reflected in my portfolio below, which is as of the end of last week. Taken collectively, gold is my largest position right now.

My thought is simply that this trade war stuff seems to be real and and getting more so, and how is that not bullish gold and gold stocks? Meanwhile I am picking these stocks up at discounts to where they were 6-12 months ago. And we just had the takeover of Klondex at a pretty fair valuation. It seems like a decent set-up.

I sold Essential Energy this week (this was after the portfolio date so its still in the list of stocks below). I listened to their fourth quarter conference call. Its hard to get excited about their prospects. Drilling activity in Canada just isn’t coming back. I’m going to stick with names like Cathedral and Aveda that have more US exposure.

I also sold Medicure this week after the news that Prexarrtan won’t be launching on the original time line. I may be jumping the gun, after all Medicure has 3 other drug launches in the next year or so. But Prexarrtan was the first and without it I don’t see much of a catalyst for the stock in the near term.

Portfolio Composition

Click here for the last eight weeks of trades. NOTE: I didn’t go back far enough in my trade search. These are the trades from Jan 15th to Jan 29th that I had previously missed.

Prices below are as of Friday, March 16th.