Emergent Biosolutions (EBS) has seen some disappointments over the last few months.  The company is the only provider of an FDA approved Anthrax vaccine and EBS primarily sells its products to the United States Strategic National Stockpile (SNS).  While EBS enjoys a relative monopoly on its vaccines, the third quarter gave investors a bit of a surprise with revenue actually declining by 24% and earnings nearly flat.  The company had a much lower level of shipments to the SNS which dramatically impacted its financial figures.

This lumpy revenue stream is not without precedent.  In the fourth quarter of 2008, a similar revenue decline took place before shipments resumed and the company recorded a strong first two quarters of 2009.  During quarters where revenue declines, profit margins take a significant hit due to ongoing research and development as well as fixed costs which continue regardless of the number of doses shipped.  The bad news is that this uncertainty causes investors to bail and drive the share price lower.  But the good news is that once the company resumes its strong growth trends, investors will likely be rewarded with a strong rebound in the share price.

Looking at the results of the third quarter, it is obvious that the company is being managed for long-term growth and management is not overly concerned with any one quarter report.  This is encouraging in an age where most investors, management teams, and board of directors micro-manage each quarter at the expense of long-term performance.  The company continues to invest in R&D which will be instrumental in developing new products or improving products already on the market.  For example, the anthrax vaccine was recently improved to handle a longer shelf-life, and the FDA approved the longer expiration date.  As a result, EBS can charge a higher price, enjoy better profit margins, and offer a higher quality product.

During the third quarter, the company added to its cash base and now has $118.8 million in cash and equivalents.  This cash can be used for acquisitions such as additional manufacturing and testing facilities which the company closed on in November, as well as to create new products and market them in a broadening target demographic.

We also continue to make significant investments in our commercial product pipeline, most notably our tuberculosis candidate, which is in a Phase IIb efficacy trial in South Africa. ~ R. Don Elsey, CFO

Most recently the stock price has been hovering between $13 and $15 as investors try to determine whether the third quarter was a change in trend or if earnings growth will return.  Since EBS has a high degree of exclusivity (and management noted that it’s contract with the SNS is scheduled to remain in effect through September 2011), it looks like the revenue base is currently stable.

Analysts are modeling earnings of $0.75 per share next year which puts the stock at a multiple of 20 times expected earnings.  This estimate is likely to be very conservative as it represents a 19% decline from 2009 earnings.  The stable revenue with the SNS as well as potential for new products and new clients should beef earnings higher and likely lead to a higher multiple on the stock.

The company has several projects in place that could result in important new products.  Don Elsey noted the tuberculosis vaccine which could be rolled out in South Africa in the near future, and the anthrax vaccine could eventually be sold to a wider target market as well.  With the high cash balance, EBS could potentially purchase another product line from a competitor and leverage this to its existing client base.

The future is somewhat uncertain, but with the stock price trading at a low level, and potential for growth in place, it makes sense to make initial or add-on purchases to EBS here.  I wouldn’t be surprised to see the stock trading above its recent $20 high in the next few months, and if the company makes a major announcement, EBS could challenge its all-time high of $27.

FD: Author does not have a position in EBS

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