A Growth Story in Molecular Diagnostics

An increasingly elderly population in the United States, a rise in chronic disease incidences, the availability of different types of tests, developments in pharmacogenomics, and a growing trend among people to detect disease possibilities early on has led to a huge upsurge in molecular diagnostics, or MDx.

MDx is a type of in-vitro diagnostic testing that helps identify the patterns of nucleic acids or proteins to test for or evaluate various disease conditions. Some of the problems in the market are increasingly complex testing methodologies and higher costs. Riding the tide of this opportunity, and addressing some of the associated problems, is Cepheid (NASDAQ: CPHD  ) . The company has a simple, innovative testing system offering a higher clinical output and low operating costs.

Growth barriers act as an advantage
The MDx market is highly regulated, and strong regulatory requirements pose a challenge to its growth. MDx products require 510(k)/IVD clearance before making them available in the market. The upcoming assay-specific coding may put pricing pressure on testing. Changes in reimbursement from individual testing and services to up-front payment for all expenses may also have a significant impact on price as well as quality.

Some of these growth barriers act as entry barriers as well, giving an edge to established players like Cepheid. New entrants will face tough hurdles bringing their products to the market, while established companies will have wide experience clearing such regulatory hurdles.

New health care reforms and testing
President Obama's new health care reforms such as the Affordable Care Act have created a growth environment for the testing and detection market. MDx is the fastest-growing segment among IVD testing, led by factors such as rapid turnaround time, high sensitivity, low cost and convenient workflow. The increasing investments in genomics and proteomics research will further drive growth in future.

It is expected that the MDx market will grow at a compounded annual growth rate of 14% between 2011 and 2016 to reach $7 billion by 2016. This is due to increasing demand for infectious disease testing (18% CAGR), hospital acquired infections (23% CAGR) and oncology (16% CAGR). New elements in Obama's health care reform will increase the demand for diagnostic tests and influence manufacturers to focus more on genetic testing for better results and improved patient health.

Biohazard detection
One interesting aspect of Cepheid's business is in its non-clinical segment. Cepheid's GeneXpert modules have been integrated with the biohazard detection system of the United States Postal Service to perform Bacillus anthracis tests. In the post-9/11 world, biohazard detection has become a growth business with worldwide applications and opportunities.

Performance drives growth
With increasing demand of clinical testing, Cepheid continues to report positive growth. In the second quarter of the 2013 fiscal year, Cepheid reported revenues of $96.0 million, an increase by 19% as compared to the same period last year. The growth was due to a rise in revenue of $16.7 million (+20%) from clinical systems and $70.8 million (+27%) from clinical reagents.

Clinical systems and reagents together increased clinical revenue by 26% over the prior year and partly offset decreased sales from the non-clinical segment. The company's adjusted gross margin was 47%, and its adjusted net income was $1.2 million, or $0.02 per share. As of June 30, the company's cash flow from operation was $4.8 million, and its cash balance was $85 million.

Peers in the MDx market
In the MDx space, Cepheid competes with Qiagen (NASDAQ: QGEN  ) and Gen-Probe, a subsidiary of Hologic (NASDAQ: HOLX  ) .

Qiagen provides sample and assay technologies that are used to convert biological materials into valuable molecular information. The company operates in four segments: molecular diagnostics, applied testing, pharmaceutical R&D, and academia. The company continues to expand its next-generation sequencing portfolio with GeneRead to enhance its assays and diagnostic business.

By performance, Qiagen reported net sales of $316.4 million, up by 3% at constant currency (CER) in the second quarter. The growth was led by molecular diagnostic (+4% CER, 49% of sales), pharma (+4% CER) and academia (+3% CER). The adjusted gross margin was 71% while the adjusted net income was $64.2 million, or $0.27 per share. The company's cash balance as of June 30 was $299.4 million. Qiagen expects to generate sales growth of nearly 5% with adjusted earnings per share of $1.13 in the 2013 fiscal year.

Similarly, Hologic expects revenue growth of 2%-4% in the coming period as a result of the impact of Gen-Probe. Hologic primarily develops, manufactures, and markets medical imaging systems, diagnostics, and surgical products. The company specifically focuses on health care needs of women.

During the third quarter that ended on June 29, revenues were $626.1 million, up by 33% over last year. Diagnostic (47% of total revenues) improved significantly in the quarter with the inclusion of Gen-Probe (up to $146.9 million.) The company's adjusted gross margin was 62.4% and its adjusted net income was $103.2 million, or $0.38 per diluted share.

The company's cash balance was $964.4 million. The addition of Gen-Probe will further enhance Hologic's performance, and the company expects to generate revenue of $2.50 billion-$2.52 billion in the 2013 fiscal year with a bottom line (adjusted earnings per share) growth of $1.46-$1.47.

Going ahead
Cepheid has a comprehensive range of products for separate analysis, including delivery systems from laboratories to hospitals or remote locations. The company's continued investment in R&D will strengthen its product portfolio. The evaluation of products in additional analysis such as protein detection, paraffin extraction, and high-level multiplexing will create growth opportunities for the company.

Rising health care costs continue to be a hotly debated topic, and even legendary investor Warren Buffett called this trend "the tapeworm that's eating at American competitiveness." To learn more about what’s happening to the health care system -- and how to potentially profit from this trend -- click here for free, immediate access.


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