Acrux Limited (ASX: ACR) operates in the biotechnology sector, amongst the shadows of market heavyweights CSL Limited (ASX: CSL), Cohclear Limited (ASX: COH) and Sirtex Medical Limited (ASX: SRX).

Despite having the smallest market capitalisation of the lot (at $125 million), I believe Acrux is a compelling investment for the speculative portion of your portfolio. Here is why.

About the company

Acrux is an innovator of patented drug delivery systems. The company holds exclusive licences to provide the delivery system used to administer three patient-preferred drugs. Therefore, Acrux’s success relies on the viability of the three drugs it administers – Axiron, Recuvyra and Evamist.

The risks

Like any biotechnology stock, Acrux is not immune to risks. One of the biggest headwinds to share price performance is the U.S. Food and Drug Administration’s (FDA) review of the health risks associated with its largest drug (by sales), Axiron.

Axiron is used in treatment of symptoms related to hypogonadism — a condition where the male testes and female ovaries are unable to produce certain hormones, causing a deficiency of testosterone in the body. Axiron is administered to combat the deficiency through testosterone replacement therapy (TRT).

In the past, Axiron’s popularity was arguably due to the use of TRTs for recreational purposes (such as body-building). New FDA guidelines mean doctors are required to prescribe Axiron to patients actually suffering from hypogonadism, given the possible heart attack and stroke risks associated with use of TRTs.

The financials

Sales

The FDA’s new requirements impacted sales dramatically. In its full-year ended 30 June 2015, Acrux reported sales revenue was down 53% to $25.4 million (compared to 2014 full-year). Profit slumped 60% to $11.1 million.

Pleasingly, however, sales revenue for the six months ended 31 December 2015 was up 27% compared to the prior corresponding period. Profit jumped 39% for the half to $9.7 million.

A recent update revealed Axiron’s net sales for the quarter ended 31 March 2016 were only marginally down on first-quarter 2015 sales, implying some rebasing of earnings is occurring. If this trend continues, investors should see some stability in Acrux’s share price going forward.

Profitability

Impressively, Acrux carries no debt and generates large amounts of free cash flows (FCF). In 2015, management used its FCFs to pay a 6 cent tax-free annual dividend, placing it on a trailing yield of 7.9%. Provided no adverse announcements in this financial year, I expect this dividend should be maintained.

Foolish takeaway

Given Acrux’s free cash flows, lack of debt and strong profitability, the foreseeable downside risks appear to be further regulatory constraints or a product recall.

Whilst I remain cognisant of the fact that adverse announcements by the FDA or any of its marketing partners could spell trouble for Acrux, I regard these risks as quite low and believe a small investment in Acrux could reap large windfalls in the future.

Too risky?

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Motley Fool contributor Rachit Dudhwala has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.