Tag Archives: REPH

Quick Update: Recro Pharma – $REPH

Well well well….

I posted about Recro here (less than 2 months ago).

Shares are down another 40% since then. Hope you didn’t purchase shares after I posted about them. It is now down 70% since I bought shares.

Q2 Summary

  • Revenue was down 50% due to lower sales and royalties.
    • One key customer had substantially less market share than last year – this was communicated in Q1. Largest revenue impact is from Verapamil as Mylan has re-entered the market. This accounted for about 2/3 of the decline.
    • Despite my initial thought, their products are affected by covid more than I thought. Some of their main products are used to treat ADHD and since there was little/no in school education, there was less demand for the product.
    • New business development was slowed due to lockdowns.
  • Lower volumes led to lower cost absorption.
    • Gross margin was 25% vs. usually having 40%+ gross margins.
    • Negative EBIT of 1 mil.
  • Market cap is now 68mil with an EV of 161mil.
  • Started Clinical Trials Materials (CTM) Services and secured multiple contracts.
    • This is in response to covid’s impact on new trials starting. It helps them leverage their logistical strength and experience to serve the customer.
  • Filed a prospectus
    • To sell up to 30mil in common to Aspire Capital at $4.40 (share price is around $2.90 now)
    • To sell up to 100mil in common, preferred, debt, warrants, or rights

My Thoughts

The most concerning thing for me in the last two quarters was the drop in gross margins without any progress on the milestones I had mentioned in the previous post. It shows that they can’t pivot their production costs quickly and are subject to market forces rather than having some power over them.

I am giving them a pass on the quarter. They lockdowns came fast and there are things that they could not have avoided. I do think the launch of CTM is a demonstration of them trying to navigate the lower activity environment. They still have a business that has high barriers to entry with products that will be in demand for the foreseeable future.

I have updated my milestones to include the CTM part of the business. The milestones are demonstrable items that will help build conviction in the stock.

New Milestones

  • Refinance high cost debt
  • Signs of significant growth in new products
  • New CEO with focus on capital allocation
  • Update guidance for 2020
  • Progress on the CTM

Am I the only one who owns this thing?

 

Thanks,

 

Dean

*the author is long shares in REPH at time of writing. I have not bought or sold any shares since my original purchase.

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Getting caught off guard; Recro Pharma ($REPH)

If you’ve been in this game long enough you are going to get caught off guard once in a while (unless you are part of Fintwit where everyone bats 1.000). I would say that of all the executive functions, emotional regulation is probably my weakest. It is kind of funny given that I realize that it takes a higher EQ than IQ to be successful at this investing thing.

There are usually some minor positive or negative surprises on quarterly or annual financial statements. More often then not these lead to a minor reaction in the share price, say 5-10%. These “surprises” are usually easily explained on the conference call or in the MD&A. Once in awhile, you really get a surprise and the stock rises or drops by 25+%. The company releases numbers and the stock gaps up or down. You had no idea and where caught off guard. These are the moves that test your conviction in the company and in your process. It’s easy to take credit for the positive surprises and blame management for the negative ones. In reality it doesn’t matter who’s “fault” it is, but how you pick up the pieces and move forward is what is important. It’s so hard to remember that in 2 or 3 years, you won’t care about this specific quarter unless you did something you regret based on the results.

This recently happened to me with REPH as they released numbers and the stock gapped down 40%. I’m going to share how I am approaching the situation now.

Here is a good post on REPH. The author does a great job going over the business and valuation. Check it out before continuing.

Despite not being in an industry that I’m familiar with, the REPH investment thesis was fairly easy to articulate:

  • decently high barriers to entry
  • deep relationships with customers
  • producing drugs that are not going away anytime soon
  • split of the 2 businesses (CDMO and specialty pharma) to focus on core competencies
  • not immediately or materially affected by COVID (at least from what I understood)
  • discount to peers and previous buyouts
  • issued guidance for the business and previously beat guidance
  • there is likely to be a push for drugs to be produced in North America given some supply shortages of certain critical drugs during the Covid pandemic

There were some things to get comfortable with:

  • high cost debt
  • no CEO for the CDMO business
  • not cheap on an absolute basis
  • not expecting stellar growth (though I am not expecting negative growth either)
  • management communication has not been great
  • compensation seems high for a business of this size, but that does seem to be normal for pharma companies

Given all this, I took half a starter position or about 3%.

Now with shares about 45% lower than when I bought, I’m left with a pretty small position.  At a this point REPH is about 2% of my portfolio. When the shares crashed, REPH occupied way more than 2% of my bandwidth. I needed to take a step back and reassess. I could average down, hold or lick my wounds and blow out the position.

Here are some questions I ask myself whenever I get one of these surprises:

  1. Is this a temporary bump in the road or is this quarter indicative of the long term prospects of the business getting worse?
  2. Is there a reasonable explanation for the surprise? Did management do everything in their control?
  3. When communicating bad news, did management take accountability?
  4. If you didn’t already own shares, what would you do?

Here’s what I came up with:

  1. I don’t think the long term prospects of the business have changed and the barriers to entry have lessened.
  2. Yes and No. They were expecting a re-entry of a competitor into their market (Mylan) and seemed to have the underestimated the impact. Covid has led to delays in reorders as customers have worked through some inventory on hand. As well, business development efforts were paused due to Covid.
  3. I do feel that they took accountability for what they could control and revised guidance was issued. They have set up a Covid task force to help navigate the pandemic. They adjusted costs and are looking to save 2 mil.
  4. If I didn’t own shares, I would likely wait on the sidelines.

Given that the position is quite small and I don’t have a better use of the capital at the moment, I’m going to hold on to my shares and not add or sell. I realize that this means that I am missing out on a potential rally in the shares.

I have come up with tangible milestones to build confidence in management before adding to my stake and working towards a full position. To me, these should all be complete by the end of the year.

  • Have a better idea of how the new competitor in one of main markets
  • Hire new CEO for the CDMO business
  • Refinance high cost debt
  • Signs of significant growth in new products to fill existing capacity
  • Meet previously issued guidance

When’s the last time you got a negative surprise? What did you do?

Dean

*the author owns shares of REPH at time of writing

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Filed under Company Analysis, Investing Lessons, Random Thoughts