Although Exact Sciences (NASDAQ:EXAS) isn’t that old of a company, a couple general rules of thumb seem to have emerged – the company’s non-invasive Cologuard test for colorectal cancer is going to continue to gain share, and shorts are going to continue to look for any cracks in the wall as a way to keep holding on to their bearish thesis. With the company outperforming expectations in 2017 (to the tune of nearly 170% revenue growth and 70%-plus gross margins) and the share price up nearly another 150% over the past twelve months, patient longs have been well-rewarded for sticking with this up-and-coming molecular diagnostics company.
Not surprisingly, given the robust growth, these shares are trading at a pretty rich multiple today. Although more beat-and-raise performances are certainly possible, and the company has only penetrated somewhere around 3% to 4% of its addressable market, I would wait for another bad news event (likely more perceived than real) before making a big commitment to the shares.
Not Much To Complain About
It has been a while since I’ve written about Exact Sciences for Seeking Alpha, but the company has continued to perform well as the company’s sales force continues to add prescribing physicians and as patent-targeted efforts like direct advertising and compliance enhancement continue to boost interest and usage.
Test volume grew more than 100% yoy per quarter in 2017, as the company’s Cologuard test continues to gain awareness and adoption with both physicians and patients. Volumes have also been helped by ongoing wins with private insurance companies – Exact ended the year with close to 90% coverage of the test and all of the major players are now onboard after UnitedHealth (NYSE:UNH) reversed its long-held position against the test in mid-2017. With greater commercial coverage ASPs have also improved, as the company’s revenue per test closed the year at nearly $500 in the fourth quarter.
Higher volume has also accelerated the overall business development plan. Gross margin for the full year of 2017 was about 10 points better than I’d expected at this point last year and the company had to spent less on SG&A items than I’d expected. Exact also took advantage of the market’s enthusiasm for its beat-and-raise quarters by issuing shares and convertible debt – bringing the company very close to filling the cash burn gap ahead of free cash flow breakeven.
Although there hasn’t been much to complain about, there are a few items that keep Exact from a perfect score. Adding more commercial insurance patients has created some headwinds in compliance, as some people are not using the test after it is ordered because of concerns about their out-of-pocket obligations. There’s also more work to do in terms of in-network coverage, and the company’s pipeline hasn’t developed quite as well as I’d hoped. Last and not least, the unusual flu season appears to be reducing/postponing the number of routine check-ups, leading management to guide to flattish sequential volume for the first quarter of 2018 and a more back-end-loaded trajectory for 2018.
Building Awareness And Usage
Although Cologuard penetration is still low in terms of the overall number of people over 50 who should be getting tested for colorectal cancer, the company has made considerable progress in building its base. The number of doctors ordering Cologuard for their patients increased more than 70% from Q4’16 to Q4’17, while the average number of orders per physician increased almost 30%. With Exact Sciences adding another 200 reps in 2018 (half of which will be external) and starting to focus more on boosting electronic orders, very strong growth should continue.
On the subject of electronic orders, only about one-quarter of Cologuard tests are ordered electronically (meaning the remainder are ordered by fax or phone). Those physicians whose EMR systems are integrated with Exact tend to order significantly more tests, so this is a meaningful potential source of growth over time (though it is likely to take time).
With the job of getting major private insurance companies to cover Cologuard mostly over (nearly 90% covered lives), now Exact Sciences can focus on getting more in-network coverage. Anthem (NYSE:ANTM) and Cigna (NYSE:CI) remain the two largest targets here, where securing in-network coverage would likely provide meaningful boosts to volume and compliance (as patients wouldn’t have to worry about paying a potential significant part of the cost). It’s worth noting that Exact Sciences recently chose to move out-of-network with Anthem Blue Cross (due to a collection of issues that was leading to lower revenue per test), but I expect management to try to renegotiate a better contract here in the future and move back to in-network.
Less Favorable Developments In The Pipeline
Relative to how things looked a year ago, Exact Sciences’ pipeline progress (or lack thereof) may be the most disappointing development.
About a year ago, Exact presented initial data on a liquid biopsy for lung cancer, showing 90%-plus sensitivity and specificity. When a second study failed to replicate those results, management moved the lung cancer test back to the drawing board. In its place the company is prioritizing a liver cancer surveillance test for high-risk populations. Early results indicate 90%-plus sensitivity and specificity for what could be a 3 million-patient target market opportunity.
The lung cancer test setback is disappointing, but not all that surprising. At the risk of stating the obvious, developing less-invasive tests for cancer (and particularly for early-stage or pre-cancer) is difficult. The company’s partnership with the Mayo Clinic has yielded biomarker discoveries for nine of the 10 most common cancers, though, and this remains an area of focus.
Research into other less-invasive/liquid testing approaches is also likely to remain fertile ground for stock volatility. Exact Sciences shares lost about 10% of their value in mid-January when an ASCO abstract was presented on a test using circulating tumor cells in a blood sample to detect colorectal cancer. While the headline numbers looked interesting at first glance (including high sensitivity and specificity), it was a single-site study that included a large percentage (71%) of patients who already had adenomas, polyps, or colorectal cancer and it seems all but certain to me that an “apples to apples” study with the target Cologuard patient population would show much weaker sensitivity for this approach.
It remains to be seen whether a liquid biopsy approach is truly viable for colorectcal cancer. It may well be the case that biology stands in the way – if relevant indicative/predictive biomarkers don’t enter the bloodstream at early stages, it’s just not going to work as well. I’d also note that Exact Sciences isn’t exactly flat-footed here either – the company has a huge database that it can leverage for its own liquid biopsy test development.
The Opportunities
In keeping with the strong outperformance in adoption, I’ve significantly increased my long-term expectations for Exact Sciences. Although I believe that it’s going to take more than a decade, I believe Cologuard will eventually get more than 20% of its addressable target market (some people are simply not going to get themselves tested, no matter what happens). I also believe that the company is going to hit $1 billion in revenue three years sooner than I thought (2021 instead of 2024) and $2 billion in 2026. All of that supports a very high annualized growth rate (over 35%) across the next decade.
I still expect positive operating margin in 2020 and I believe the company will achieve 30%-plus operating margins within the next seven years. I expect positive free cash flow in 2020 and meaningful FCF generation (double-digit FCF margins) in 2022. While free cash flow growth rates aren’t relevant now, I do expect over $500 million in annual free cash flow within the next 10 years
The “but” is that the valuation already incorporates a lot of this expected growth. The shares already trade around 13x my 2019 revenue estimate and above my DCF-based fair value in the $40’s. I don’t rule out the possibility of future beat-and-raise quarters, though, and I would also note that I no longer include any contributions from future tests beyond Cologuard. Likewise, I would note that it is entirely normal for such a fast-growing med-tech company to trade at very high multiples at this point in its development.
The Bottom Line
Fear of missing out is a relevant issue here, and it is up to individual readers/investors to decide if this is a name to chase. High-growth/high-multiple stocks have never been the core of my portfolio, and I’m not all that inclined to stretch for Exact Sciences here, even though I do like the company and the test. Given that meaningful pullbacks in the share price aren’t exactly rare, I’d be tempted to wait in the hopes of exploiting another one of those … keeping in mind the risk that such a pullback could start from a share price meaningful above today’s level.
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.
Be the first to comment