In many investing circles, drug development is considered one of the premier growth industries of the present and the future. This isn't exactly a new view per se. Investors have been enamored of pharmaceutical firms as growth companies for decades, and legendary investor Phil Fisher even made mention of the industry's prospects in his book Common Stocks and Uncommon Profits, which was originally published way back in the 1950s.
In more recent times, investor sentiment toward biotechnology companies has swung from euphoria to disappointment several times over the past decade. Since this is the area of the drug world where most small companies reside, it may be worth digging around to see if there are any interesting ideas in the biotech and drug development sector currently.
Some investors automatically steer clear of biotech and drug development altogether, deeming the business models of many small drug shops as too far toward the speculative end of the investing scale for their stomachs. I usually include myself in this camp, especially regarding tiny development stage firms that trade more on hopes for potential home run drugs in the pipeline than actual cash flows. As a result, the absence of positive operating cash flow and reportable earnings tends to keep most small drug firms off the Foolish 8 idea list. But when one does slip on, it's usually worth taking notice and looking into the story.
In this latter case, Miami-based drug developer Noven Pharmaceuticals (Nasdaq: NOVN) provides an interesting story. There are a few things that differentiate this former Foolish 8 stock from other small drug firms. First, it operates in a niche known as transdermal and transmucosal drug delivery, or drug patches. Second, the company already has a few products on the market, most notably in the hormone replacement therapy (HRT) area. These products include a family of estrogen patches and a combination estrogen/progestin patch marketed under the highly creative CombiPatch brand name.
Noven's current line-up of drug patches is selling well, allowing the company to turn in 32% revenue growth and a 38% rise in EPS in the first quarter, the results of which were reported yesterday. Continued growth is expected throughout the remainder of the year, and the firm's management reiterated guidance for full-year EPS between $0.60 and $0.70. Currently, the handful of sell-side analysts covering the company are content to split the difference at $0.65 per share for the mean estimate, which puts Noven on a track to see 30% year-over-year EPS growth this year.
Ordinarily, the bright outlook for continued growth from existing products would be enough to support a small company's stock price in the market. But in the drug development business, companies are not given much leeway by investors to sit on the laurels of successful existing products and watch the cash flows roll in. There is a heavy emphasis by both investors and the companies themselves on innovation -- as in constant innovation. Successful drugs eventually lose their legs, meaning Noven and other small drug firms are always under the gun to come up with new products to keep their future growth prospects alive.
Noven's pipeline has been the most interesting part of the firm's story in recent months, as its stock has been knocked around by a set-back with a product in the later-stages of the development process. The product under heavy scrutiny right now is a drug patch for treating attention deficit hyperactivity disorder, or ADHD. Essentially, Noven's product is a patch form of the highly successful (and not to mention controversial) drug Ritalin. The number of Ritalin prescriptions in the U.S. is running at an annual rate of about an 11 million, according to one report, so this is a big potential market for a small firm like Noven to tap.
Noven had been hoping that its ADHD patch, called MethyPatch, would turn into its first $100 million product. But early last month, the company announced it has decided to delay the filing of the New Drug Application (NDA) for MethyPatch with the Food and Drug Administration after the results from a Phase III study were found to be inconclusive. That announcement caused a 32% one-day dive in the firm's share price to $19 per share, and the stock actually dipped to under $17 per share last week.
However, Noven is rebounding today thanks to its Q1 showing and on additional details regarding where the MethyPatch situation currently stands. The company is hoping that the drug won't be in limbo for long, and plans are underway for a supplemental study to prove its effectiveness.
On a conference call with analysts yesterday, Noven blamed the previous study problems not on the drug itself, but rather on a study group that was too "inclusive" of marginal ADHD patients. While all of the patients in the original Phase III study passed diagnostic tests for ADHD, the group as a whole was too far tilted toward less severe than more severe ADHD patients, according to Noven's management. The company believes this created a flaw that will be fixed in the supplemental study, which will hopefully allow for more conclusive data supporting the drug's effectiveness.
The company maintains that ADHD patients with a higher "degree of impairment" showed the greatest improvement when treated with MethyPatch. The hope is that the NDA will be filed with regulators next year, with commercialization of the product slated for 2003. That makes Noven a small-cap drug firm to watch over the near-term, especially at its reduced valuation of about 35 times this year's expected earnings. In the interim, investors can learn more about ADHD and the growth of Ritalin use in this country at this informative Medicating Kids website that accompanies the PBS program, Frontline.
Brian Graney likes analyzing drug companies, but doesn't much like taking medicine. At the time of publishing, he did not own shares of any of the companies mentioned above. The Motley Fool is investors writing for investors.