I bought shares in liver cancer treatment company Sirtex Medical Limited (ASX: SRX) recently because I think December's share price crash was overdone for the following reasons.
Still a growing business
Dose sales growth was disappointing for the first half of 2017 compared to recent years at only 5.6%, but the company is still moving forwards. Sales are lower on a sequential basis (i.e. compared to the second half of 2016) but there is a seasonal effect which could account for this.
An attractive market
In November, competitor BTG announced strong double digit sales growth for its own radioembolization therapy in the half-year ending September. Given BTG and Sirtex's treatments are very similar this suggests to me that the market for the product has not yet become saturated (although it is possible that BTG's sales tailed off in the last three months of the calendar year).
I think it is unlikely that sales could decline any time soon as there are limited alternatives for liver cancer sufferers. As far as I can work out Sirtex's product, SIR-spheres, is still largely only used in the salvage setting when all other options have failed. In many parts of the world access to SIR-spheres remains limited even in these unfortunate cases and so I believe there is still growth potential in this segment.
This is important considering the upcoming results of three clinical studies to be announced in the first half of this year. In my opinion, the outcome of this research will not affect the salvage market because they are not testing SIR-spheres effectiveness in this setting. It has already been proven that administering SIR-spheres kills liver cancer, what is unclear is whether they are more effective than drugs currently used in earlier stages of the disease.
Potential class action is a secondary issue
I expect a class action to be launched against Sirtex on the grounds of inadequate market disclosure because of recent events culminating in the dismissal of Gilman Wong as CEO earlier this month.
Although I think the merits of such an action are questionable, I possess no legal training or experience and so have assumed for my valuation that the company will be obliged to pay out the $100 million of cash it currently holds. But even if this does happen it will take years to play out and in any case I do not think the impact is large enough to derail my thesis.
Large potential upside
There is every possibility that one or more of the upcoming studies display positive results. If so, this could lead to SIR-spheres moving up the treatment hierarchy and greater funding being made available by insurers and public health bodies. This could mean a return to high double-digit growth rates for Sirtex for several years.
Low price
Based on expected profits for 2017, Sirtex is trading on a price-to-earnings ratio (PER) in the high teens. However, this fails to account for the fact that at least $20 million will be spent on clinical trials this year. This expenditure should largely disappear once three of these studies are completed in the first half, with a fourth study expected to finish in 2018.
Also, Sirtex spends around $10 million per year on other research completely unrelated to SIR-spheres. If you consider this an investment rather than a cost as I do, then it makes sense to adjust valuation accordingly. In my view, the true underlying PER of Sirtex is closer to 10 which implies that this company is currently priced for very little growth.
My investment in Sirtex depends on a lot of assumptions and so it is just a small position. It is possible that legal action could lead to charges well in excess of $100 million although this would be largely unprecedented. Also, there is the chance that poor study results cause a pullback in existing funding for SIR-spheres but given the substantial clinical evidence in favour of the therapy to date I feel this is unlikely.
