American States Water Company: Shares More Than Fully Priced At Present (NYSE:AWR)


Investment Thesis

While the business appears to be a safe investment, American States Water (AWR) shares appear more than fully priced at present. A wait and watch approach is appropriate. A detailed analysis of the company’s financials and its outlook appears below.

The Dividend Growth Income+ Club Approach

The logo of the DGI+ Club explained:

Total Return, Dividends, Share Price

The only way an investor can achieve a positive return on an investment in shares is through receipt of dividends and/or an increase in the share price above the buy price – the only way. For more information and background on share value assessment please visit, “Forget Irrelevant Valuations, Returns Based Investing Is A Better Approach” and “Free Cash Flows: Let’s Have A Discussion Towards A Better Understanding.”

Assets, Liabilities

The engines and the lubrication, along with human talent, drive the business. Shareholders have no legal rights to or ownership of the assets. Shareholders in a limited liability company have no legal obligations in respect of the liabilities.

“Equity Bucket

Shareholders have an equitable entitlement to their equity in the company. Equity is increased by capital raised from shareholders, and by earnings of the company. While shareholders have an equitable entitlement to their equity in the company, they have little to no say in how the equity is distributed. In some companies, management actions in respect of the shareholders’ equity do not always benefit shareholders and can be highly detrimental to shareholders. At the DGI+ Club, in addition to reviewing profitability, balance sheet strength, liquidity, and other metrics, we take the extra step of checking the “Equity Bucket” for “leaks”, i.e., effective distributions out of or other reductions in equity that do not benefit shareholders.

Below, I address:

  1. Historical And Potential Future Shareholder Returns
  2. Checking the American States Water “Equity Bucket”

American States Water: Assessing Historical And Potential Future Shareholder Returns

In this article and in most of my articles, I seek to show how targeting a desired return on an investment in shares can be facilitated by actually estimating what future returns will be, based primarily on analysts’ EPS estimates and other publicly-available data. After all, gaining a return is the primary aim of most investing.

First, I provide details of actual rates of return for American States Water shareholders investing in the company over the last four to five years.

Table 1 – American States Water Historical Shareholder Returns

For many stocks where I create a table similar to Table 1 above, I find a wide range of returns indicating a degree of volatility and risk. Table 1 above shows the results for American States Water were returns of 13.5% to 20.3% for six of eight different investors, each investing $3,000 over the last five years and holding to the present. The two remaining, and most recent investors had returns of 8.1% and negative (6.7)%, due to their higher buy prices of $75.4 and $86.64 in 2019. These rates of return, ranging from positive 20.3% to negative (6.7)%, are not just hypothetical results. They are very real results for anyone who purchased shares on the various dates and held through to July 23, 2020. In the above examples, the assumed share sale price is the same for all investors, illustrating the impact on returns of the price at which an investor buys shares.

Projecting Future Shareholder Returns

If rate of return is the basis on which we judge the performance of our investments, then surely we should be seeking to estimate future likely rates of return when we are making investments. But how do we do that? I use proprietary models to generate net income, balance sheet/funds flows, and projected rates of return going out three to five years. Much of this is automated but still involves a great deal of research and business and data analysis to back up the projections. Let us first look at the traditional approach to assessing value of a stock for investment purposes.

Assessment Based On Quant Ratings For Share Investment Decisions

Share buy price, dividends, share sale price, and duration the shares are held are the only factors affecting the return on an investment in shares. That makes potential share sale price the single most important and uncontrollable unknown when making a share buy decision. My expertise is in fundamental analysis, but I do recognize, any methodology, Quant or Elliott Waves or other techniques providing assistance in assessing possible future share price direction, can be of benefit to share investors. I find SA Quant ratings useful for both screening for stocks of interest and as a form of due diligence.

Figure 1

Quant ratings for American States Water show the company is rated particularly poorly on value, at present share price levels, and also on profitability.

Assessment Based On Analysts’ EPS Estimates

Figure 2 – Summary Of Analysts’ Adjusted Non-GAAP EPS Estimates

Some observations on contents of Fig. 2

  • The analysts’ quarterly EPS estimates for consensus, high and low, do not add to the yearly EPS estimates for consensus, high and low. This is generally the case because the analyst with the high estimate for the year is not necessarily the analyst with the highest estimate each and every quarter, ditto low, and consensus figures. To overcome this, I adjust the quarterly EPS figures in the proportion of yearly totals to quarterly totals.
  • The further out estimates are made, the less certain they become. The 2022 to 2024 estimates, due to being covered by only 3 or fewer analysts, will have additional uncertainty.
  • The range between high and low estimates is not great, suggesting reasonably quantifiable future expectations.

I incorporate the above analysts’ EPS estimates from SA Premium into my rate of return projections utilizing my proprietary 1View∞Scenarios DashboardsTM further below. As for Quant ratings, EPS and EPS growth estimates do not quantify the rate of return that can be expected for the stock in question.

Figure 3 – Non-GAAP P/E Ratios, Historical And Future Estimates

Figure 3 is primarily designed to determine an appropriate range of non-GAAP P/E ratios for determining estimated future share price levels for American States Water. This is necessary for quantifying estimated future rates of return. Figure 3 also informs us of past non-GAAP EPS growth rates compared to forward estimates of EPS growth based on analysts’ consensus estimates. Analysts’ consensus estimate of EPS for 2020 is estimated to be up 7% on 2019 suggesting little expected impact from the COVID-19 pandemic in 2020. Analysts’ consensus estimates for 2021 to 2024 EPS growth range from 5.7% to 7.8% YoY. These rates of EPS growth compare to quite variable historical growth rates for 2017 to 2019, ranging from negative (1.1)% to positive 21.6%. It should be understood, in quantifying the estimated rates of return below, I’m relying on the soundness of analysts’ consensus estimates of EPS. The other important factor is determining appropriate future P/E ratios, which is fraught with difficulty. P/E ratios are impacted by issues both at the macro and micro level. I don’t believe I will have any arguments against the notion current P/E ratios are influenced by expectations of future EPS growth rates. Below, I quantify potential rates of return under various scenarios utilizing my proprietary 1View∞Scenarios Dashboards.

Assessment Based On Quantification Of Potential Rates Of Return

My forward-looking analyses bring another dimension – the quantification of potential returns utilizing various pieces of financial information already available.

Table 2.1 – 1View∞Scenarios Dashboard

Table 2.1 shows buying at the current share price would provide indicative rates of return through end of 2022 of 8.5% for the consensus case, 9.0% for the high case, and 7.9% for the low case. These rates of return assume EPS results in accordance with analysts’ consensus, high and low estimates and a constant adjusted non-GAAP P/E ratio of 37.66 (same as current TTM P/E ratio). This P/E ratio of 37.66 is above the historical median of 34.64 per Fig. 3 above. American States Water P/E ratio compares to peers as follows, per this peer comparison from SA Premium.

Figure 4

Table 2.2 – 1View∞Scenarios Dashboard

Table 2.2 uses similar assumptions to those in Table 2.1 above, except for a lower 34.64 P/E ratio, in line with the historical median per Fig. 3 above. At the lower P/E ratio 2022 consensus case rate of return reduces from 8.5% per Table 2.1 to 5.0%, with similar reductions for high and low cases.

Table 2.3 – 1View∞Scenarios Dashboard – Stress Testing

Table 2.3 uses the same assumptions as in Table 2.2 above, except for a decline in the P/E ratio by around 26% from the historical median of 34.64 to 25.72. The 25.72 is still a little higher than American States Water’s historical low P/E ratio of 24.57 per Fig. 3 above. At the assumed lower P/E ratio, indicative returns through end of 2022 are negative (6.5)% for consensus, negative (6.1)% for high case, and negative (7.1)% for low case. By holding on until 2024, continuing EPS growth effect on share price, and receipt of dividends eventually enables the average yearly return to turn positive. In Table 2.4 below, I show the result of holding off buying to wait for a possible lower share price.

Table 2.4 – 1View∞Scenarios Dashboard Projected Rates Of Return – Allowing For A Lower Share Buy price

Table 2.4 assumptions are similar to Table 2.2, except I have assumed a P/E ratio 10% below the historical median, and an 11.6% fall in share price in 2020 occurs before buying. At the assumed lower P/E ratio of 31.17 and the buy price of $71.90, indicative returns through end of 2022 are 6.0% for consensus, 6.5% for high and 5.3% for low cases. It should be noted the American States Water share price reached a 2020 high of $95.67 on February 18, 2020, before the impact of the COVID-19 pandemic caused a market-wide downturn. The share price fell to a low of $65.11 on March 16, before recovering to the current closing price of $81.34 on July 23.

Checking The American States Water “Equity Bucket”

Table 3.1 American States Water Balance Sheet – Summary Format

Period January 1, 2017 to March 31, 2020 (3.25 years)

Table 3.1 shows American States Water has increased net assets used in operations by $212 million over the last 3.25 years. The increase was funded by $110 million in equity and $102 million in net debt. The $110 million increase in shareholders’ equity over the last 3.25 years is analyzed in Table 3.2 below.

Table 3.2 American States Water Balance Sheet – Equity Section

I often find with companies, while they produce earnings that increase shareholders’ equity, significant amounts of distributions out of, or other reductions in equity, do not benefit shareholders. Hence the term “leaky equity bucket.” This is happening to some extent with American States Water as explained below.

Explanatory comments on Table 3.2 for the period January 1, 2017, to March 31, 2020:

  • Reported net income (non-GAAP) over the 3.25-year period totals to $220.4 million, equivalent to diluted net income per share of $5.97.
  • The company shows some net income and EPS growth over the period.
  • The non-GAAP net income excludes $10.8 million of income regarded as unusual or of a non-recurring nature, in order to better show the underlying profitability of American States Water. These adjustments decrease reported non-GAAP EPS over the 3.25-year period by $0.27 per share.
  • Other comprehensive income includes such things as foreign exchange translation adjustments in respect to buildings, plant, and other facilities located overseas and changes in valuation of assets in the pension fund – these are not passed through net income as they fluctuate without affecting operations and can easily reverse in a following period. Nevertheless, they do impact on the value of shareholders’ equity at any point in time. For American States Water, these items were $1.2 million positive and increased EPS by $0.03 over the 3.25-year period.
  • There were share issues to employees, and these were a significant expense item. The amounts recorded in the income statement and in shareholders’ equity, for equity awards to staff, totaled $7.7 million ($0.21 EPS effect) over the 3.25-year period. However, the market value of these shares is estimated to be higher by $14.4 million ($0.39 EPS effect) than the amount recorded for stock compensation expense purposes over the 3.25-year period. This understatement of expense is equivalent to ~6.5% of reported non-GAAP EPS over the 3.25 years, so in accounting terms, it is a material understatement of the real cost of stock compensation. This is not a matter unique to American States Water. This Ernst & Young publication on Returning capital to shareholders, expresses a similar concern –

Companies seek to offset executive compensation dilution. Buybacks can replace the shares or fund the options that companies award as compensation. A director recently cautioned that this practice could cause companies to inadvertently increase the cost of executive compensation plans: “If we are using hard dollars to offset stock dilution, we should treat those hard dollars as a compensation expense. Otherwise we are not recognizing what we are actually spending to compensate our people.”

  • By the time we take the above-mentioned items into account, we find, over the 3.25-year period, the reported non-GAAP EPS of $5.97 ($220.4 million) has decreased to $5.89 ($217.5 million) net income from operations, added to funds available for distribution to shareholders.
  • There were no share repurchases to offset issues to staff.
  • In the period under review, net debt as a percentage of net debt + equity has increased from 41.8% at end of 2017 to 45.9% at end of Q1-2020.

American States Water: Summary And Conclusions

Based on current high P/E multiple, the stock appears overpriced at present. But this is a highly subjective assessment. If investors in general are prepared to continue accepting these high multiples in the long term, then the shares will continue to trade at relatively high prices. At a constant multiple, share price growth will move in line with EPS growth. This is true whether the constant P/E ratio is 15 or 34. The only time P/E ratio affects returns is when there is a change in the P/E ratio.

Investors chasing yield will look for a reliable dividend payer with a dividend yield above the treasury yield – that is what pushes up P/E multiples to new highs as treasury yields fall. The risks of large capital losses are greatly magnified at high P/E multiples. Those risks could be realized if there is a change in investor sentiment brought on by an increase in interest rates or a general market downturn for any number of reasons. On the other hand, if recessionary effects are greater than expected, the share price could benefit from a flight to safety.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. I do not recommend that anyone act upon any investment information without first consulting an investment advisor and/or a tax advisor as to the suitability of such investments for their specific situation. Neither information nor any opinion expressed in this article constitutes a solicitation, an offer, or a recommendation to buy, sell, or dispose of any investment, or to provide any investment advice or service. An opinion in this article can change at any time without notice.





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Nvidia expresses interest in SoftBank’s chip company Arm Holdings: Bloomberg News By Reuters


© Reuters. NVIDIA logo shown at SIGGRAPH 2017

(Reuters) – SoftBank Group Corp’s chip company Arm Holdings Ltd has gathered takeover interest from Nvidia (NASDAQ:) Corp, Bloomberg News reported https://bloom.bg/30R4Kh5 on Wednesday, citing people familiar with the matter.

Nvidia and SoftBank did not immediately respond to requests for comment, while Arm declined to comment on the report.

SoftBank, which acquired Arm for $32 billion in 2016, is exploring options including a full or partial sale or a public offering of the British chip designer, the Wall Street Journal reported last week.

The Japanese conglomerate had recently approached Apple Inc (NASDAQ:) to gauge its interest but the latter is not planning to pursue a bid, Bloomberg reported, citing people familiar with the matter.

Arm’s licensing operation would fit poorly with Apple’s hardware and software focused business model and there may also be regulatory concerns about Apple owning a key licensee that supplies so many rivals, according to the report. Apple did not immediately respond to Reuters’ request for comment.

SoftBank last month unveiled a series of transactions to divest more than $21 billion worth of stock in U.S. wireless carrier T-Mobile US (NASDAQ:) Inc, as it seeks funding for a $41 billion share buyback and debt reduction plan.

Disclaimer: Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. All CFDs (stocks, indexes, futures) and Forex prices are not provided by exchanges but rather by market makers, and so prices may not be accurate and may differ from the actual market price, meaning prices are indicative and not appropriate for trading purposes. Therefore Fusion Media doesn`t bear any responsibility for any trading losses you might incur as a result of using this data.

Fusion Media or anyone involved with Fusion Media will not accept any liability for loss or damage as a result of reliance on the information including data, quotes, charts and buy/sell signals contained within this website. Please be fully informed regarding the risks and costs associated with trading the financial markets, it is one of the riskiest investment forms possible.





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Tesla stock soars more than 5% after company reports surprise Q2 profit


Tesla Inc. stock rose more than 5% late Wednesday after the Silicon Valley car maker reported a second-quarter GAAP and adjusted profit, setting it on a course to join the S&P 500 index and surprising investors as most of the quarter was beset with coronavirus-related stoppages.

Tesla
TSLA,
+1.52%

said it earned $104 million, or 50 cents a share, in the quarter, contrasting with a loss of $408 million, or $2.31 a share, in the year-ago quarter.

Adjusted for one-time items, Tesla earned $2.18 a share, swinging from an adjusted loss of $1.12 a share a year ago. Sales fell 5% to $6.04 billion from $6.35 billion a year ago.

Analysts polled by FactSet expected an adjusted loss of 2 cents a share on sales of $5.15 billion.

The numbers were “very strong,” setting Tesla for S&P 500 index inclusion, said Alyssa Altman, an auto-industry consultant with Publicis Sapient.

“Tesla is showing the market they move fast, make quick decisions and are not afraid of failure,” she said. “They made bold choices to reduce costs while still launching a new model with all the challenges that go with a new model launch. In doing that, they are seeing success and confidence from the market. Any profit in this environment is good and shows resilience in uncertain times.”

The “real news,” said Gene Munster of Loup Ventures, “is Tesla hit profitable and free cash flow with sustainable measures. The company did not pull a one-time lever to get to profitability.”

In a letter to investors, Tesla said its progress in the first half of the year “has positioned us for a successful second half of 2020. Production output of our existing facilities continues to improve to meet demand, and we are adding more capacity.”

Tesla did not provide an outlook for 2020, saying it was still “difficult” to predict shutdowns and shifts in consumer sentiment for the second half of the year.

As it had done in its first-quarter shareholder letter, Tesla did not address the ongoing pandemic directly, with the word appearing only on standard legal disclosures at the very end of the document.

It also kept its 2020 goals unchanged from its first-quarter letter, mentioning again “capacity” to achieve the milestone of selling more than half a million vehicles in the year.

“We have the capacity installed to exceed 500,000 vehicle deliveries this year, despite recent production interruptions. While achieving this goal has become more difficult, delivering half a million vehicles in 2020 remains our target,” it said in the letter.

It has enough liquidity is enough to fund production and long-term capacity expansion plans, it said.

The company said it continues to build capacity for the Model Y, its compact SUV, at factories in Berlin and Shanghai, and it remains on track to start Model Y sales from both locations in 2021. Tesla Semi, the company’s long-haul electric truck, is also slated for 2021.

In the call with analysts, Tesla’s Chief Executive Elon Musk said the Austin, Texas, area had been selected as the next U.S. “gigafactory” site, and preparations are underway, he said.

Before Wednesday, the Silicon Valley car maker had reported three consecutive quarters of GAAP and adjusted profit. That fourth consecutive quarterly profit opens up the possibility of joining the S&P 500 index within a few months.

Tesla pinned the surprise profit on “fundamental operational improvements,” with costs with factory shutdowns offset by cost-cutting measures. GAAP operating margin reached nearly 5%, the company said, adding it expects it to continue “to grow over time, ultimately reaching industry-leading levels.”

Tesla earlier this month reported second-quarter sales that crushed Wall Street expectations, even as its sole U.S. car-making factory was shuttered for most of the quarter under local shelter-in-place orders.

The sales surge was one of the recent catalysts for the stock rally, which has pushed Tesla’s market valuation around $300 billion, about $95 billion ahead of Japan’s Toyota Motor Corp.
TM,
-0.00%

and the No. 1 car maker in the world by market value. The shares ended at a record $1,643 on Monday, and hit an intraday record of $1.794.99 on July 13.

In April, Tesla also surprised investors by posting a first-quarter profit. Musk kept the surprises going on a post-results call with analysts, veering off script to condemn the closures put in place to curb the spread of the virus and likening them to fascism.

Musk also ignited Twitter and legal spats that prompted President Donald Trump to chime in on the factory closure.

Tesla’s Fremont, Calif., factory reopened in May in defiance of local shutdown orders. The standoff was eventually resolved, with Tesla reopening the plant after filing a health and safety plan with local authorities.

See also:Tesla stock is ‘overheated;’ remain cautious despite hype, BofA analysts say

Earlier Wednesday, analysts at Bank of America Securities kept their cautious stance on Tesla, saying that the stock was overheated and urging investors to “remain cautious despite hype and momentum.”

The analysts increased their price target on the shares to $800, from $500, but kept their equivalent of a sell rating. The mean price target on Tesla from 31 analysts polled by FactSet is $912, with the top of the range being above $1,500.

Tesla shares have gained nearly 300% this year, comparing with gains around 1% for the S&P 500 index
SPX,
+0.57%

and contrasting with a loss around 6% for the Dow Jones Industrial Average
DJIA,
+0.61%

.



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Billionaire Bill Ackman has a $4 billion ‘blank check’ to buy a company, but he hasn’t said which one


Billionaire hedge-fund manager Bill Ackman’s largest-ever “blank check” company went public Wednesday, with more than $4 billion in its kitty to acquire an as yet undetermined company, and it has two years to pick one.

Pershing Square Tontine Holdings Ltd.
PSTH.UT,
+8.35%

is a special purpose acquisition company (SPAC), formed to buy one private company and take it public by way of an acquisition similar to a reverse merger. The company raised $4 billion, as it sold 200 million shares in its initial public offering which priced at $20 a share.

The company’s stock started trading on the New York Stock Exchange Wednesday morning, with the first trade at $21.10, or 5.5% above the IPO price. It has climbed steadily since, to be up 9% in afternoon trading.

Ackman has built this war chest at a time, as he said in an interview on CNBC Wednesday, that he is “long-term bullish” on America and the stock market, although he was bearish on highly indebted companies.

See: Ackman says he’s ‘long-term bullish’ on the stock market but ‘bearish’ on highly indebted companies

SPACs are shell companies without an operating business, formed only to buy private companies, or act as a backdoor means for a company to go public without the usual regulatory and Wall Street fanfare, and costs, associated with an traditional IPO. Read more about ‘blank check’ companies.

Renaissance Capital, a provider of institutional research and IPO exchange-traded funds, said it does not include SPACs in their IPOs because they are not operating companies. Investors should therefore be cautious, as the SPACs can’t be valued, other than for the cash they hold, until after an acquisition is made.

While there have been some “moonshots” in which companies going public via SPACs have outperformed the IPO and broader stock market, such as Virgin Galactic Holdings Inc.
SPCE,
+3.89%

and DraftKings Inc.
DKNG,
-0.37%

, most have underperformed, Renaissance said.

Pershing Square Tontine is sponsored by Pershing Square TH Sponsor LLC, which is wholly owned by three investment funds — Pershing Square Holdings Ltd., Pershing Square L.P. and Pershing Square International Ltd. — all of which are managed by Ackhman’s hedge fund Pershing Square Capital Management L.P. Ackman is also chairman and chief executive officer of the SPAC.

Citigroup, Jefferies and UBS Investment Bank are the joint bookrunning managers of the IPO. There are a host of other bankers involved, including those from co-lead managers of the IPO CastleOak Securities L.P., Loop Capital Markets, Ramirez & Co. Inc. and Siebert Williams Shank.

In connection with the IPO, Pershing Square funds have committed to buying a minimum of $1 billion worth of equity units, each consisting of one share of common stock and one-third of a warrant to buy stock, at a price of $20 per unit. The funds will have the right to buy up to an additional $2 billion worth of equity units.

That gives the SPAC a minimum of $5 billion of cash equity capital to make a purchase. Although many other funds of equal or larger size formed to make acquisitions often buy 100% or majority interests in multiple companies, Pershing Square Tontine said it plans to merge with just one private company and take it public, through a deal that gives it only a minority interest in the newly public company.

When the SPAC disclosed its intent to go public in June, it said it was planning to raise $3.45 billion by offering 172.5 million shares at $20 a share. At that time, as is usual with SPACs, it said if a business combination wasn’t completed within 24 months, or 30 months if a letter of intent is executed, then it would return 100% of the shares to owners through a cash payment.

Ackman chose what has been a stellar year so far for IPOs to take Pershing Square Tontine public. The Renaissance IPO ETF
IPO,
-0.98%

, which holds the largest IPOs that have been completed in the past two years, has run up 39% year to date, while the S&P 500 index
SPX,
+0.19%

has gained 1.1%.



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Orchard Therapeutics: An Undervalued Gene Therapy Company (NASDAQ:ORTX)


Orchard Therapeutics (ORTX) was founded in 2015 and has been dedicated to advancing gene therapies for ultra-rare diseases. In 2018, they acquired GSK’s portfolio of gene therapies and became a public company. Orchard now has one of the most extensive and advanced pipelines in the gene therapy space. They have proven that their technology is effective, safe and durable. One of the scientific cofounders has taken on the CEO role and has initiated a new strategic plan to transition Orchard to a successful commercial stage company. Shares are trading near a 52-week low yet two of their gene therapy treatments have completed clinical studies, are likely to be approved and should begin generating revenue as early as 2021. Based on projected peak sales, Orchard Therapeutics is undervalued and could double if regulatory approvals and sales follow.

The Orchard Platform

Orchard has a technology platform for ex-vivo autologous hematopoietic stem cell gene therapy. Simply put, this means that stem cells which produce blood cells are genetically corrected in a lab and reinserted into a patient in hopes of curing their disease permanently. This approach can be applied to many monogenetic diseases, some of which are life-altering and/or life-ending diseases, for which there are no effective treatments. Orchard Therapeutics’ approach is a technically challenging procedure which involves removing a patient’s cells (HSCs), inserting a lentivirus which carries a working copy of the defective gene and then cryopreserving (freezing) the cells.

The cells can then be shipped to an Orchard-approved treatment site where the patient is treated by wiping out the defective HSCs. Next, via an IV infusion, the patient is given the corrected cells which should engraft into the bone marrow and produce healthy cells permanently. Orchard has administered this type of treatment to more than 170 patients in 7 diseases and it has been shown to be effective, safe and durable for as long as 19 years.

OTL-200 for Metachromatic Leukodystrophy (MLD)

MLD is caused by a faulty gene and results in patients missing a critical enzyme. Onset of MLD can happen in infancy, childhood or even adulthood. It is thought that this missing enzyme causes the myelin sheath and the nerve fibers that should be protected to break down. Muscles work poorly and are rigid, patients have seizures and progress to blindness. Affected children will not develop normally cognitively or physically and thus require extraordinary care due to their condition. According to Orchard’s CEO, physician Dr. Bobby Gaspar, in its most aggressive form, patients are “vegetative by ages 2-3 and often dead by ages 5-6.”

Dr. Marc Patterson, MD, a neurologist at Mayo Clinic describes MLD as “inexorably progressive and leads to premature death in all cases.” The only treatment available currently is a stem cell transplant which may slow the disease but must be done early in the disease process. Published literature suggests that stem cell transplants carry a meaningful risk of complications, have inconsistent outcomes and are not particularly effective in aggressive late‐infantile MLD.

Patients treated with OTL-200 have been followed for up to 9 years and it has been shown to be effective in both late infantile and early juvenile patients. Dr. Valeria Calbi, a hematologist at San Raffaele Scientific Institute, summarized the outcome for 29 patients who have been treated. 26 patients are still alive and have, “significantly superior gross motor function measure scores compared with untreated patients, along with positive effects on cognitive function. These data demonstrate that the majority of patients treated with gene therapy at pre-symptomatic and early symptomatic stages of their disease experienced clinical benefit, while all patients in the natural history cohort showed the expected rapid decline in motor and cognitive function.”

After seeing treated patients, the mother of an MLD patient who is paralyzed, blind and end stage wrote, ”experts in the field called the results from GSK’s (Orchard’s) clinical trials of gene therapy for MLD “stunning.” Children who should have been unable to talk or walk, who needed feeding tubes and hospice care, were instead attending school and riding bicycles and living remarkably normal lives… published papers could not show the amazing things I had witnessed, like kids with MLD eating hot dogs, running outside, and talking to their parents. They were getting a chance to grow up because of the work GSK was doing.”

Figure 1: Source: Orchard Therapeutics

Currently, the only treatment available is a stem cell transplant but OTL-200 appears safer and much more effective. Homology Medicines (NASDAQ:FIXX) has a gene therapy in preclinical stages for MLD. Takeda (NYSE:TAK) has an enzyme replacement treatment that is in clinical trials but isn’t scheduled to be approved until 2023. If it proves effective, TAK-611 would be chronically administered, perhaps intrathecally, on a weekly basis. It may be a useful treatment for more advanced patients but it is likely to be expensive, the ongoing intrathecal administration would be burdensome and it is not curative.

Profits and OTL-200 for MLD

The University of Washington is piloting a screening program to determine the incidence of MLD as figures in the literature vary considerably from 1 in 40,000 births to 1 in 160,000 births. Orchard Therapeutics estimates that 200-600 patients are born annually with MLD in developed countries. The MLD Foundation estimates approximately 450 are born with MLD annually in the US and other developed countries.

Figure 2: Source- The MLD Foundation

Identifying patients with MLD early is challenging because newborn screening is not routinely performed. The diagnosis is often difficult to make and can occur later in the disease course given many practicing physicians will never see a single case of MLD. Additionally, the symptoms are similar to cerebral palsy or can appear to be psychiatric initially, thus, it can easily be misdiagnosed. A challenge for Orchard is identifying patients early because early treatment is required for OTL-200 to be effective.

Orchard is piloting screening for newborns in both Italy and New York to achieve this end. They believe that routine screening will be needed to maximize the number of patients treated. However, screening for an ultra-rare disease is not something likely to be quickly implemented or uniformly adopted. Experts like Dr. Michael Gelb believe this may change because there is a valid rationale for performing routine screening. According to Dr. Gelb, “The treatment works so well that interest in newborn screening [for MLD] is escalating.” Given the uncertainty about the incidence of MLD and the current difficulties in patient identification, it is particularly difficult to project peak sales.

Pricing for OTL-200 has not been announced but it is likely to be very high. The most similar product is Zolgensma, a gene therapy for SMA which is also a devastating and deadly disease. Zolgensma is also a gene therapy product with curative potential and commands a price of $2.1 million in the US. Insurance companies are covering it and Novartis posted sales of $186 million a quarter recently. Despite an enormous price tag for treatment, these are extremely rare conditions and due to that, the price per member per month, is actually very small. It is estimated that insurance coverage for gene therapy adds less than $12 annually to a premium.

Assuming a price of $2,000,000 per patient and 100 patients treated annually, OTL-200 would provide revenue of $200 million annually. One under-appreciated factor in assessing the value of OTL-200 is that due to the complexity of manufacturing, Orchard may be the only producer of a gene therapy for MLD even after the patent expires. Orchard Therapeutics is anticipating a EU approval this year for OTL-200 and is planning a European launch in early 2021. They plan on filing an IND in the US this year. They have received feedback from the FDA and EMA and believe they have adequate datasets to prove efficacy and safety.

OTL-103 for Wiskott Aldrich Syndrome (WAS)

According to Boston Children’s Hospital, Wiskott-Aldrich syndrome is an ultra-rare genetic disease that impairs immune function and prevents platelets from being properly produced leading to bleeding disorders. Orchard’s CEO, Dr. Bobby Gaspar, who is a physician, described it as a very challenging disease. He described that patients tend to be susceptible to severe infections due to the defects in their immune system and tend to have serious bleeding episodes from minor injuries. Patients also develop autoimmunity and cancers. The median life span of these patients was reported in the literature to be approximately 14 years with a stem cell transplant being the only treatment option currently.

In a study published in Lancet Haematology, nine patients treated with OTL-103 were all alive, all had engraftment of genetically corrected HSCs, and all had an improvement in platelets and immune function. Patients had a statistically significant decrease in infections and were able to discontinue the use of platelet transfusions due to an absence of severe bleeding events. The authors concluded that OTL-103 provided “a valuable treatment option” and the study reached all of its endpoints. Patient’s pre-treatment status acted as the placebo for the clinical trial. Some of these patients were treated with the cryopreserved product and it showed efficacy equal to the fresh product. This validates that patients can be treated at distant sites which better allows for access.

As with MLD, there are widely varying figures of incidence in the literature. Orchard Therapeutics estimated that WAS has annual incidence of 100-300 births and a prevalence of 3K-5K patients of whom it is estimated that 55 percent are untransplanted. Dr. Gasper describes it as a slower progressing disease and that patients can be treated in later stages. Because of this, OTL-103 has a better commercial opportunity as there are a few thousand existing patients who could benefit from treatment. If we estimate $2 million per patient and 300 patients treated annually, that produces $600 million in annual sales. In 2021, Orchard will submit to the FDA and EMA for regulatory approval so commercial launches may occur in 2022.

The Pipeline

Orchard has prioritized development of OTL-203 for MPS-1, another ultra-rare devastating disease. Maria Ester Bernardo, MD, Ph.D., an investigator noted that initial results of the early stage trial looks promising. She reported that “the trial results to date have shown promising preliminary clinical effects on motor skills, IQ and growth in the first two patients with 12 and 18 months of follow-up,” Orchard has also dosed the first patients in an early stage trial in MPS-IIIA. These programs are likely to move to later stage trials adding to Orchard’s pipeline. There are other companies working on AAV gene therapies for these indications including Regenixbio, Abeona and Lysogene so these may be more competitive markets for Orchard Therapeutics.

Orchard has announced that it will be investing in programs in less rare indications. They will be targeting genetic forms of frontotemporal dementia and Crohn’s disease. Orchard has other more advanced programs that have been placed on hold including their beta thalassemia program but they will be seeking partners to advance these.

A Strategic Plan

The strategic plan to become a profitable commercial enterprise is multifaceted. They have signed a 5-year extension with their contract manufacturer to produce OTL-200 and OTL-103 as well as for additional pipeline products. This eliminates the need to invest in manufacturing at this time. They also entered into a license agreement with GSK for their lentivirus cell line technology which should enable improved manufacturing efficiency. They laid off 25 percent of their staff to further reduce costs. Dr. Gasper, the CEO stated that, “we took a view that to prioritize what we were doing right now, deliver on that and invest in some R&D on the larger indications… That is where the full value of Orchard lies and the full value of hematopoietic stem cell gene therapy lies,”

Risks

Clearly, the availability of curative therapies such as OTL-200 and OTL-103 is a blessing to a family who receives such a shattering diagnosis. The largest risk for investors is whether Orchard Therapeutics can profitably provide these therapies. It is inherently difficult to estimate peak sales in ultra-rare diseases where incidence and prevalence figures as well as pricing are uncertain. An additional risk for investors is whether the EMA and FDA will find the clinical data already available for OTL-200 and OTL-103 sufficient for approval. Moreover, the need to raise capital which would likely result in dilution is also a risk for investors.

Financials/Share Price

In 2021, revenue should start to flow in if European approval is obtained for OTL-200. An estimate based on the assumptions described in this article is that peak sales for OTL-200 and OTL-103 could reach $800 million. Orchard has provided no specific revenue projections but the chart below illustrated the source, relative scale and timing of revenue growth.

Figure 3: Source- Orchard Therapeutics

The company has cash on hand of approximately $264 million which they expect to be sufficient to fund operations through 2022. Given this, an equity offering could be necessary prior to a commercial launch. It should be noted that management initiated this restructuring plan in order to preserve cash and appears to be adverse to unnecessary dilution.

The company’s current market cap is $533 million and the enterprise value is $293 million suggesting shares are significantly undervalued relative to the revenue opportunities. Peak sales are always difficult to project but particularly so with ultra-rare diseases where there are few comparisons, especially for curative therapies. However, even if we assume Orchard’s treatments for MLD and WAS collectively only reach $400 million in peak sales, if we apply a 3x multiple on sales, and discount assuming an 85% chance of regulatory approval, that inputs a market cap closer to 1 billion. This implies shares could double. Interestingly, when Orchard went public in 2018, it quickly hit a valuation of $1.25 billion. Today, its market cap is $533 million but it has two products that have been shown to be effective and are approaching regulatory approval.

Institutional Ownership/Analyst Thoughts

JPMorgan analyst Anupam Rama has a price target of $17 and has an overweight rating on Orchard’s shares. The analyst noted that the transition to a commercial stage company is likely to occur before 2021 and sees “broad potential” for the pipeline. Orchard has strong institutional support and recent filing show ownership by biotech hedge funds RA Capital, Deerfield Management and Baker Brothers.

Conclusions

Orchard Therapeutics is well-positioned to deliver transformative therapies for multiple diseases from their proven platform. Although the markets for their products are incredibly small, competition is virtually non-existent and the rewards and barriers to entry are high. Given the precedent of very high pricing for these life-altering potentially curative treatments, it appears Orchard can do well financially while doing enormous good for patients. The currently depressed pricing of Orchard Therapeutics’ stock offers an opportunity for patient investors who believe in the financial viability of the model.

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Disclosure: I am/we are long ORTX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article is for informational purposes only and is not a recommendation to buy or sell and security.





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