Cipher Pharmaceuticals (TSX: CPH) is a specialty pharmaceutical company with a robust and diversified portfolio of commercial and early to late-stage products. Cipher acquires products that fulfil unmet medical needs, manages the required clinical development and regulatory approval process, and markets those products directly in Canada and indirectly through partners in the U.S. and South America. Cipher is focused on building strategic sales and distribution partnerships, out-licensing products, and selective investments in drug development to assemble a broad portfolio of prescription products that serve unmet medical needs.

Investment Rationale

• Robust Sequential Quarter Performance: On a Sequential quarter basis, the company reported a Net Profit margin of 24.6% against a negative margin in the previous quarter. This was driven by positive operating and higher EBITDA margin in Q1FY21.

• Discounted Valuation: From the EV/Sales standpoint, the company is trading at a steep low valuation, as Cipher’s TTM EV/Sales multiple stood at 0.852x, whereas the industry median stood at 2.6x, which implies a steeply discounted valuation. Further, a discounted valuation, robust business model, along with strong balance sheet places Cipher’s stocks well for the upside move.

• Higher ROE Compared to Peers: Cipher Pharmaceuticals have a respectable ROE of 10.1%, which is higher compared to the industry median ROE of 5%. This reflects a competitive edge, Cipher’s shareholder are having within the industry. Also, Cipher is a specialty pharmaceutical company with a robust and diversified portfolio of commercial and early to late-stage products. Therefore given the high ROE and high-profit retention, we would expect the company would be delivering strong earnings growth in future.

• Consistently Improving Liquidity Profile: CPH’s liquidity profile has consistently improved over the past eight quarters, which implies the improving quality of earnings and higher free cash flow availability. Further, it also ensures that the company has adequate liquidity to cover its short-term obligations comfortably.

Current Ratio Movement

• Significant Debt Reduction and Strong Debt Protection Metrics: The company has significantly reduced its debt profile from June 2019 and become virtually debt-free at the end of Q1FY21. At the end of Q1FY21, the total debt to equity ratio stood at 0.05x, and the long-term debt to total capital ratio stood at 4.7%, which is quite manageable given the healthy cash flow in the business. Also, the company has strong debt protection metrics with Net Debt to EBITDA ratio stood at 0.12x.

Total Long Term Debt Movement

• Stable Outlook: For FY21, the group expect the full-year benefit of the cost reduction plan and continued profitability and strong cash flow. Further, the group expects improved profitability of the hospital business through the distribution agreement with Verity. Moreover, the group is selectively pursuing product and business acquisitions in a prudent manner with a focus on the high growth potential and near-term profitability. Also, the group is advancing on key development programs, including Lucy product portfolio with the key development partner Galephar; refinements to the MOB-015 program for nail fungus with Moberg with a possible expansion of territories; completion of proof-of-concept studies for tattoo removal program; negotiation of development agreements for two to three dermatology products.

• Breakout on Weekly Price Chart: On the weekly price chart, CPH share price broke out of the downward sloping trend line recently. Since then, prices are continuously sustaining above the breakout level. This suggests a potential upside in the stock price from the current level.

Technical Price Chart, Analysis by Kalkine Group

• Bullish Trend is Largely Intact: CPH shares are trading in a long-term bullish cycle, as the price closed above the crucial long-term support level of 200-day SMAs, and also in the last trading session, its shares traded above its crucial short-term support level of 50-day SMA. This implies that the technical strength in the stock is largely intact. Further, the leading momentum indicator MACD is still hovering above the 9-day SMA signal line.

Technical Price Chart, Analysis by Kalkine Group

• Risk Associated to Investment: The company’s business model is exposed to a variety of risks ranging from License risk as the company needs approval from various drug authorities before commercializing its products. Risks Related to Intellectual Property, the company’s research, development and commercialization activities may infringe, or otherwise violate or be claimed to infringe or otherwise violate patents or patent applications owned or controlled by other parties. Forex Risk, the company is exposed to currency risk through its net assets, namely its lease obligation and certain recurring transactions denominated in Canadian dollars. Liquidity risk for Investors, As a penny-cap market capitalization of the company, investors are exposed to liquidity risk as the daily average volume in these penny cap companies are usually low, and Others as well.

Financial Highlights: Q1FY21

Source: Company

• Total net revenue was USD 5.4 million for Q1 2021, compared to USD 5.9 million for Q1 2020, reflecting an 8% decline on a YoY basis. The decline was on account of a decline in Licensing revenue, which decreased by USD 0.5 million to USD 2.8 million for the quarter compared to USD 3.3 million for the three months ended March 31, 2020. This was And partially offset by an increase in product revenue, which increased by USD 0.1 million or 5% to USD 2.7 million for Q1 2021, compared to USD 2.6 million for the comparable period in 2020.
• Licensing revenue from Absorica in the U.S. was USD 2.3 million for the quarter, a decrease of USD 0.5 million compared to USD 2.8 million for the three months ended March 31, 2020. Absorica's market share for the three months ended March 31, 2021, was approximately 4.2% compared to 6% for the three months ended March 31, 2020, according to Symphony Health. Market share, including Sun Pharma's Absorica LD was approximately 5.4%.
• Licensing revenue from Lipofen and the authorized generic version of Lipofen was USD 0.4 million for the three months ended March 31, 2021, a decrease of USD 0.1 million compared to USD 0.5 million for the three months ended March 31, 2020.
• Product revenue for the remaining brands, Ozanex, Beteflam, Actikerall, Brinavess, Aggrastat and Vaniqa was USD 0.1 million, compared to USD 0.2 million for the three months ended March 31, 2020.
• Total operating expenses increased to USD 3.4 million for the quarter compared to USD 2.3 million for Q1 2020. The increase in operating expenses for the three months ended March 31, 2021, was primarily due to the provision for legal settlement in connection with Trulance.
• Selling, general and administrative expense was USD 1.2 million for the quarter, a decrease of USD 0.2 million or 17% compared to USD 1.4 million for the three months ended March 31, 2020.
• Income from continuing operations was USD 1.3 million, or USD 0.05 per basic and diluted share in Q1 2021, compared to income from continuing operations of USD 2.5 million, or USD 0.09 per basic and diluted share in Q1 2020.
• The Company had USD 13.3 million in cash and no debt at March 31, 2021. The Company generated USD 4.3 million in cash from operating activities in the first quarter of 2021 and used approximately USD 0.2 million in cash during the quarter from financing activities.

Top-10 Shareholders

Top-10 Shareholders together hold around 41.2% stake in the company, with Mull (John D M.D.), Inc., and Mull, Craig James are major shareholders in the company holding approximately 36.9% and 1.64%% respectively.  Strategic Ownership in the company stood at 42%.

Valuation Methodology (Illustrative): EV to Sales based Valuation Metrics

Note: Premium (discount) is based on our assessment of the company’s growth drivers, economic moat, competitive advantage, stock’s current and historical multiple against peer group average/median and investment risks.

Stock Recommendation:  During the first quarter of 2021, the group continued to execute against its stated strategy to right-size the business, optimize the cost structure and broaden the portfolio through key partnerships. The group entered into a co-promotion agreement with Verity Pharmaceuticals for the marketing, sales and co-promotion of Brinavess, Aggrastat, and Trevyent. The management believes that working with Verity's experienced sales force will not only drive down costs but also enhance profitability within the hospital business.

Further, in the first quarter, results were impacted by a legal provision in connection with the impairment of Trulance; excluding this provision, EPS would have come in at 10 cents, demonstrating the strong earnings power of the business.

Subsequent to quarter-end, the group has launched Absorica AG with its marketing partner Sun Pharmaceutical Industries, Inc. We believe that this would broaden Cipher's isotretinoin portfolio and ensure that the group have products to serve each segment of this market and maximize the value of the portfolio.

Further, the company has significantly strengthened its balance over the last few quarters and virtually become debt-free, with a total D/E ratio of 0.05x, with significantly higher debt protection metrics. Also, liquidity position has also bolstered over the recent quarter, and current liquidity position ensured adequate liquidity to cover short-term obligations. Based on technical analysis, the group has support at CAD 1.09 level.

Therefore, based on the above rationale and valuation, we recommend a "Speculative Buy" rating on the stock at the closing price of CAD 1.35 on June 01, 2021.

*Depending upon the risk tolerance, investors may consider unwinding their positions in a respective stock once the estimated target price is reached or if the price closes below the support level.

1 Year Technical Price Chart (as on June 01, 2021). Analysis by Kalkine Group

*Recommendation is valid at June 2, 2021 price as well.

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