Investors love a clean story. They want to know that a stock is worth buying on a key takeaway sentence, such as “sales are growing” or a “new product holds great promise.” Paradoxically, when a company can lay claim to both catalysts, its shares can suffer.
Case in point: little-known Derma Sciences (NASDAQ: DSCI), which would be more appreciated by investors if it solely focused on its profitable wound care dressing market. Investments in a potentially significant new product, however, are causing the company to report near-term losses.
While some investors shun such unprofitable companies, in the case of DSCI, they shouldn’t. And soon they won’t. That’s because DSCI is inching closer to regulatory approval for its new product, and soon enough, investors may be focusing on the big profits this company could generate in 2016 and 2017.
Wound Care — Who Cares?
In any major pharmacy, you’ll find hundreds of different types of products lining the shelves, and frankly, specialized bandages that are placed on wounds don’t stand out as a popular product. You don’t really need one unless you’ve bruised yourself on the ball field or are a diabetic prone to foot ulcers.
According to industry research firm BioMedGPS, sales of such products reached $ 1.4 billion worldwide in the third quarter of 2013, which equates to a roughly $ 5 billion annual market. Industry leader Smith & Nephew (NYSE: SNN) accounts for more than 20% of sales. With $ 80 million in wound care dressing sales in 2013 (projected to grow to $ 113 million by next year), DSCI doesn’t even crack the top five.
Still, it’s a nicely profitable business, with gross margins in the upper 30% range. Recent tuck-in acquisitions of products with even better margins are expected to help DSCI’s gross margins into the low 40% range by next year, according to Oppenheimer (NYSE: OPY).
What Investors Are Missing About Derma Sciences
What you won’t find in those numbers is the impressive progress for DSC127. And to understand its promise, you need to know about the flaws of current advanced wound care products.
Although basic wound care products come with topical ointments to help the body on a path to natural healing, more advanced products often use an angiotensin, which can speed healing, but restricts blood vessels and increases blood pressure.
DSC127 is a patented analog that has a similar profile to the natural peptide angiotensin, but doesn’t trigger a vascular response, and therefore, doesn’t increase blood pressure. Why is that a big deal? Because the fastest-growing category of advanced wound care sales is going to people with diabetic foot ulcers. And people with diabetes are bad candidates for any drug that spikes blood pressure.
DSC127 also rapidly accelerates a process known as collagen deposition, a key process in wound healing.
Up until now, DSCI’s clinical progress has seemed quite slow. The company completed Phase I clinical trials in 2007 and then took another four years to complete Phase II testing. Very promising Phase II results were released in early 2011.
“Based on odds ratio analysis, patients treated with DSC127 0.03% were 2.3 times more likely to have their wounds heal completely compared with patients treated with placebo/standard of care,” the company noted in a press release, adding that DSC127 generated no safety concerns.
Following that news, shares nearly doubled over the course of a few weeks to around $ 12. Three years later, they are still in the low teens.
Blame goes to the snail-like pace of further clinical trials. The company took until March 2013 to file a plan for Phase III trials, and that study won’t be completed until next summer.
The company won’t have all the data analyzed until the end of next year, at which time it will presumably file for an application for approval by the Food & Drug Administration (FDA).
The fact that this entire clinical trial (in all phases) will cost upwards of $ 60 million has been a sore point with some investors, but they should focus on the fact that, if successful, DSC127 faces a major market opportunity.
According to management, “DSC127 represents a platform technology that addresses a potential market of well over $ 1 billion with the U.S. diabetic foot ulcer market alone exceeding $ 300 million.” They add that DSC127 is also aimed at the scar reduction market, which management estimates to be a $ 4 billion market. In addition, the company may pursue the market of people that have suffered skin damage from radiation therapy, which affects 850,000 Americans every year.
So how do you come up for a value for this stock? Steven Lichtman, who follows the company for Oppenheimer, recently wrote that “little DSC-127 value is reflected in shares at current levels.” His $ 21 price target is really a moving target, based on near-term organic growth for DSCI’s existing product lines.
Frankly, DSC127, if approved, is likely worth $ 500 million, $ 1 billion or more. We simply can’t say with certainty, but we can say that it is worth more than the company’s current $ 330 million market value, which again just reflects the value of the existing business. In effect, this stock may be worth two or three times the current price when this business model matures.
Shares may start to move higher in coming quarters as DSCI provides Phase III trial updates, more analysts start following the company, or a major drug company signs on as a partner. Those potential catalysts are enough to get interested in the stock right now. My $ 23 target represents 75% potential gains from current levels.
Recommended Trade Setup:
– Buy DSCI up to $ 17
– Set stop-loss at $ 11
– Set initial price target at $ 23 for a potential 35% gain in 12 months