Investors were having their doubts about Codexis (CDXS -3.45%) well before the coronavirus pandemic punished stock markets. At first, those concerns focused on whether the stock could live up to its premium valuation. Later, investors grew frustrated with a slower-than-expected pace of progress in key areas for the business. 

While there are certainly risks that cannot be overlooked, the small-cap stock is now trading at half the all-time high established in late 2018. Investors with a long-term mindset might be wondering if that's a price that's too good to pass up.

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What does Codexis do?

Codexis designs enzymes by combining molecular biology, machine learning, and high-throughput genetic engineering. Enzymes -- complex biological molecules that accelerate chemical reactions -- power biological life, but they also have utility outside their natural settings.

For instance, enzymes are often added to laundry detergent to allow clothes to be washed in cold water, saving energy. Enzymes are also used in diagnostic tests in healthcare settings, in metalworking processes, and to accelerate industrial chemical reactions ranging from petrochemical refining to pharmaceutical ingredient manufacturing.

Codexis generates revenue by supplying enzymes tailored to the needs of industrial customers, selling licenses to its machine learning software platform, and collecting payments from drug development agreements. Generally speaking, the business has performed well in recent years. The company reported full-year 2019 revenue of $68.5 million, up from $60.6 million in 2018 and $50 million in 2017. Operating losses have also been relatively manageable, helping to limit risky fundraising transactions. 

While Codexis forecasts full-year 2020 revenue of at least $78 million, the most important source of revenue is expected to decrease this year. Management also expects a significant increase in operating expenses in 2020 as the company pours more effort into drug development activities. How does guidance for the year ahead factor into the small-cap stock's risk profile in light of the coronavirus pandemic?

A technician moving a reactor in a drug manufacturing facility.

Image source: Getty Images.

Is Codexis stock too risky?

Before the coronavirus pandemic arrived, Codexis issued disappointing full-year 2020 product revenue guidance of $25 million to $27 million. That compares with revenue of $29.5 million in 2019, $25.6 million in 2018, and $26.7 million in 2017. 

The stagnation isn't ideal. Product sales are the most important source of revenue for the business. Unlike software licensing payments or drug development milestone payments, sales of enzymes are recurrent (to a degree, anyway). If an enzyme is required to manufacture a drug product, the drug manufacturer is likely to place multiple orders over the market life of the drug. Even if the purchases from one customer are erratic, increasing the number of customers can smooth over choppy revenue recognition. 

Codexis is increasingly relying on non-recurring revenue sources, primarily drug development partnerships, to achieve growth. There's nothing inherently wrong with that strategy. In fact, it could prove lucrative. 

A drug development pact with Nestle Health Science in phenylketonuria (PKU) could earn Codexis up to $85 million in development and approval milestones, up to $250 million in sales milestones, and royalties on drug sales. A separate agreement with Nestle Health Science will pursue the development of a drug candidate for a gastrointestinal disorder, while a recently announced collaboration with Takeda will develop materials for use in up to seven gene therapy programs. Financial terms for the latter two haven't been disclosed.  

Of course, drug development agreements are only valuable if they are supported by clinical progress -- and investors have zero clinical data to factor into the company's valuation right now. That could remain the case considering the coronavirus pandemic has halted clinical trials across the industry.

It's also worth remembering that while the headline value of a collaboration is often impressive, the majority of the value potential is weighted toward later stages of clinical development, regulatory approval, and sales ramp-up efforts. In other words, it'll be quite some time before Codexis is positioned to collect all $85 million in remaining development and approval milestones from the PKU collaboration with Nestle Health Science.

A higher-risk, high-reward stock

For investors with a long-term mindset, Codexis might offer a favorable risk-reward profile at its current market valuation of $650 million. The company expects full-year 2020 operating expenses to increase by "only" $19 million from last year's total, about half of which would be offset by expected increases in cost-free research and development revenue. 

That said, it's reasonable to assume that the business, like many others, will need to withdraw full-year 2020 guidance in response to the uncertainty created by the coronavirus pandemic. Drug manufacturing, food manufacturing, and clinical trials -- all key components of revenue generation for Codeixs -- will be disrupted by state lockdown orders.

Therefore, investors might not want to get too greedy at the current stock price. It's probably best to keep Codexis stock on your watch list and await the next update from management, which should come sometime in May.