Molecular diagnostics company Exact Sciences (NASDAQ:EXAS) thinks there's a $4 billion U.S. market opportunity for its proprietary colorectal cancer test, Cologuard. Revenue from the self-administered test is growing fast and has a lot more room to run.
With sales and popularity bounding upwards, a mountain of bets against the company's continued success isn't exactly what you'd expect. As of Feb. 27, a whopping 31.5% of all the company's shares available for trading were sold short. That makes this one of the most bet-against stocks on the market.
Have the bears gone crazy, or should the bulls be nervous? Have a look at some arguments from both camps so you can decide for yourself.
What the bulls say
Colon cancer treatment is generally successful when the disease is caught in its early stages, but it remains America's second-deadliest malignancy. Estimates from the American Cancer Society illustrate just how hesitant patients can be about undergoing screenings that could save their lives. This year, it expects a stunning 50,260 deaths and just 135,430 new diagnoses.
Invasive colonoscopy remains the detection gold standard, but compliance is an issue. However, Exact Sciences' Cologuard screening aims to solve this problem. Cologuard involves an at-home sample collection kit that patients can perform and return on their own time, and it appears to be gaining popularity. Last year, Exact Sciences recorded 244,000 test completions, a 135% rise over the previous year.
This year, Exact Sciences expects another big leap, to 415,000 completed tests -- but that's just a drop in the bucket. Guidelines recommend screening for about 80 million Americans every three years, and the company now boasts insurance coverage for 72% of them.
Although Exact Sciences doesn't break out specific figures from each end payer, we know that Medicare kicks in $512.43 per test, and the company contends that a 30% share of the U.S. screening market would lead to about $4 billion in annual sales. With a market cap around $2.5 billion at recent prices, realizing such a large share would lead to windfall gains for long-term investors, as most stocks trade at multiples several times annual sales.
What the bears say
Exact Sciences' Cologuard revenue projections are awfully exciting, but there's a long way to go. At recent prices, the stock is trading at a sky-high 23.7 times the amount of revenue it reported last year. Price-to-sales ratios in double-digits are generally optimistic, but this figure suggests years of continued growth at already-impressive present levels. At such a lofty valuation, any hints Cologuard revenue growth might taper off during the next few years would almost certainly lead to heavy losses from present levels.
Cologuard's relative inaccuracy forms the cornerstone of the bear case against Exact Sciences. The gold-standard test, invasive colonoscopy, delivers a positive result in 95% of patients that actually have colorectal cancer or benign growths that can also be problematic. The Cologuard test boasts a 92% sensitivity to the presence of cancer, but only 42% for non-cancerous tumors.
Even more troubling is Cologuard's relatively low 87% specificity rate. This means about 13% of people receiving a positive Cologuard result don't actually have cancer or benign growths, but they'll need a colonoscopy anyway. That's a few percentage points worse than colonoscopies and far worse than other forms of non-invasive testing. This pokes some holes in bull arguments based on overall cost efficiency driving demand.
Exact Sciences' bottom line, or lack thereof, has also emboldened short-sellers to up their bets against the stock. Although the number of tests completed jumped, the company isn't much closer to reaching profitability than it was a year ago. One factor that isn't helping is the less than thrilling percentage of test kits ordered by physicians to the number of samples received and completed.
The company instituted a national TV campaign and started a system of follow-up calls and letters, but compliance continues to be less than thrilling. About a third of the Cologuard kits sent out last year weren't completed.
In 2016, the company's annual loss widened, to $167.2 million from $157.8 million during the previous year. Exact Sciences finished 2016 with about $311.1 million in cash, cash equivalents, and marketable securities. If it can't narrow that gap fast, it will need to take on some debt, or visit the equity tap. Either would almost certainly drive the stock price lower.
What this Fool believes
I think Cologuard makes a fine supplement to colonoscopy, and Exact Sciences' ability to secure coverage for a majority of recommended patients has been nothing short of impressive. That said, my experience as a parent makes me question the ability of the non-invasive, self-administered nature of the test to drive up compliance. Despite fresh memories of painful trips to the dentist, my kids won't brush their teeth properly -- much less floss -- without someone standing over them. The reported percentage of unreturned test kits suggests that a great deal of adults won't put up an ounce of prevention to avoid a pound of cure either.
Human nature might not favor Exact Sciences' gross margins, but it's still too early to say whether or not the company will be able to squeeze out a profit with increased scale in the years ahead. One thing I do know is that the diagnostic industry is incredibly competitive. It's probably just a matter of time before a much larger peer enters the arena with a test that pressures Cologuard margins even further. While I wouldn't risk a short position, this is one stock I plan to avoid for now.