The Frustration that is Martek Biosciences (Nadaq: MATK)
Let's get right to it shall we? Over the past few weeks, I watched MATK, a stock I followed as an analyst, rise on shorts closing out their positions ahead of the EPS report (shorts close positions by buying shares they have already sold). This drove the shares from a level of around $28 to near $31. During this time period, I noticed market conditions would not be friendly for high beta shares due to several factors. During this period, I parked capital in a gold stock Yamana Gold (AUY) and an oil services stock Oceaneering International (OII). Having made some capital in those and seeing near term risk in the oil sector and some profit taking pending in gold, I positioned some capital in Martek Biosciences ahead of their EPS report.
This is a high beta stock, and those are the kind that exaggerate market moves; the market was down Wednesday on negative news out of some corporate giants like Ford etc. Ford hired a new CEO, signaling that things are worse than they expected at the company.
I first discovered Martek at the Emerald Ground Hog Day Conference in Philadelphia in February of 2003. I went to the conference to see another company present, and because I love returning to my home town of Philly. I needed to phil my time for the rest of the day, and Martek looked the most interesting within its time slot. That's when Henry "Pete" Linsert, the then CEO, captured my attention. He announced that Martek's product, a vegetarian source of DHA, "could be the next calcium". He said we could someday find DHA in everything from baby formula to orange juice. I was more impressed with the company's progress in the period up to the conference. They had spent quite a long time developing their product, and well-protecting it and the production process with a series of patents. More importantly, they had signed on all the major baby formula producers, outside of Nestle', which came along later. These companies had decided to offer a premium formula including DHA/ARA combination found in mothers' milk. Scientific studies had shown that this combination was important in the early development of the brain and eyes. Infants who had taken the nutrients had gained a higher IQ and better eye acuity later in their childhood. This clearly was an easy sell to parents seeking to provide their children with every advantage in a competitive world. It provided the formula makers an opportunity to expand margins through differentiation. The company went from relatively no revenues to over $200 million in a very short period. The stock price appreciation in '03 reflected the product's potential in formula as well as within a much larger market, the larger food products market. I foresaw some pending issues however, and I wrote about them in my reports as I downgraded the stock from a "strong buy" to a "buy". I noted that a company with little experience manufacturing product and with a talented, but relatively speaking, inexperienced management team, was likely to run into "growing pains". And they did... A blackout in Italy spoiled the only source of ARA, which Martek outsources. It lead to supply delays, angry customers and revenue and profit shortfalls. Then, a fire at a plant in the US, at the time a key to its production, again led to supply shortfalls. Then, due to customer frustration, the formula makers built up a safety stock of supply without notifying Martek, and this led to a revenue shortfall, again a negative surprise for investors. Finally, the company's efforts to gain new revenue streams were not moving as swiftly as the analyst community had forecast. The stock languished as investor sentiment turned sharply negative. So what's changed?Martek has insured its supply of ARA will not run short by contracting to produce if necessary on its own, while also convincing the supplier to produce domestically. Martek has built a new plant at a second location, insuring its own supply of DHA in the event of a production facility issue. More importantly, management is better overseeing its communication with the investment community, expressing its expectations in a more reserved manner. Thus, it has beaten EPS estimates on four consecutive occasions (I believe 5). This is effectively helping to again turn investor sentiment, but this time in a positive direction. Also aiding sentiment, is the flow of new food and infant formula product deals and partnerships being signed. The company has agreed with the likes of General Mills, Kellogg's, Coca Cola, Hains Celestial, and others to provide its DHA as an ingredient within their cereals, yogurt, soy milk and other products. Revenues from the food product segment are expected to "dwarf" the formula market. Also, the company expects its domestic formula customers to soon begin transitioning to a DHA inclusive product completely, which should help to take market penetration within the US from the 80s% up to near 100% in one quick swoop. International growth is accelerating as well within the formula market. Last quarter, the company exceeded estimates by 19% on the EPS line. All indications were that the company would exceed estimates and raise guidance again. I was somewhat concerned when the company did not raise guidance when they presented at a conference a few weeks ago, but I thought it was possible that the company's accounting department was not ready to state anything with confidence; this is likely with such a small company. Briefly, I believe valuation is greatly understated, as I expect a good deal of revenue and EPS contribution from food products in 2007. Even if estimates are correct, this stock is priced at a P/E of 23 FY 07 (Oct.) estimates while sporting a forecasted long term growth rate of 26%. So, at a PEG of 1 or lower, with growth I see above 35%, I love this stock more than any other long-term. Short term it continues to fluctuate with other high beta shares. In this regard, this is because it is a small company and revenues are low and highly dependent on a handful of customers. However, it is not a biotech stock in reality, but a food company. Yes, it is small, but over time I expect the stock's beta ratio to gravitate toward 1 or lower. It's a high growth food company, and those tend to perform well. It should also benefit from the pivot point turn in sentiment, moving from greatly under-appreciated to properly and eventually over-appreciated. These are the best kinds of investments, ones benefiting from growth potential, and greatly undervalued at the same time.
So that's the story, and here's why I view the disappointment in the management's guidance for FY Q4 October, and the resulting price drop, as possibly the last great buying opportunity for the shares. The shares were down a good $4 plus after hours and now more than $6, as the company provided revenue guidance 10% below Q3 and EPS guidance 25% short. The market saw this as a huge let down, and just another failure when Martek had us believing in it once again. However, we must devoid ourselves of these emotions that can influence our logical decision making. The CFO pointed out last quarter that this quarter might be impacted by customers' plant shutdowns for maintenance. Well, it seems he was off a quarter. Unfortunately, when it became clear there was not going to be a problem this quarter, the market assumed growth was so strong that there was not a problem at all. However, growth was strong because, I believe, a few important customers (or just one- Mead) acquired DHA/ARA inventory stockpiles ahead of their planned shutdowns, boosting the quarter's performance while impacting Q4. You see, they will not be buying in Q4 as they have already purchased supply. We need to understand that this is a very limited time issue, but it will happen the next time the customer does this, and the Martek management team needs to better manage the situation. However, it does not really affect the long term cash flow projections for Martek, and therefore, does not affect our valuation. Another thing of concern, was that Martek will reduce purchases of ARA from its supplier, as it does not need the inventory now. However, reduced purchases means higher pricing that will impact margins for a few quarters. My only question is this, why doesn't Martek have this same kind of pricing power with its own inconsistent purchasing clients. And why does it not have power with its supplier? Poor execution. But this does not dilute the revenue and earnings potential Martek still has in the food products segment, and should not dilute the stock price as much as it has today. So, I view this disappointing news as a driver for a bargain purchase of Martek shares. This is a long-term investment. Over the near-term, I cannot properly predict where the shares will go at this point. It could be a wild ride on Thursday and it could last through the week. But when it settles, I think it will be a bargain for the taking. It's only one product launch announcement away from a similar move, but up! That's the best buy, and its why you drive to the outlet mall. Why should your stock investment be any different than your clothing purchase. Buffet says buy when everyone else is heading for the hills. Well, that will be the case today. Good shopping to you.
This is a high beta stock, and those are the kind that exaggerate market moves; the market was down Wednesday on negative news out of some corporate giants like Ford etc. Ford hired a new CEO, signaling that things are worse than they expected at the company.
I first discovered Martek at the Emerald Ground Hog Day Conference in Philadelphia in February of 2003. I went to the conference to see another company present, and because I love returning to my home town of Philly. I needed to phil my time for the rest of the day, and Martek looked the most interesting within its time slot. That's when Henry "Pete" Linsert, the then CEO, captured my attention. He announced that Martek's product, a vegetarian source of DHA, "could be the next calcium". He said we could someday find DHA in everything from baby formula to orange juice. I was more impressed with the company's progress in the period up to the conference. They had spent quite a long time developing their product, and well-protecting it and the production process with a series of patents. More importantly, they had signed on all the major baby formula producers, outside of Nestle', which came along later. These companies had decided to offer a premium formula including DHA/ARA combination found in mothers' milk. Scientific studies had shown that this combination was important in the early development of the brain and eyes. Infants who had taken the nutrients had gained a higher IQ and better eye acuity later in their childhood. This clearly was an easy sell to parents seeking to provide their children with every advantage in a competitive world. It provided the formula makers an opportunity to expand margins through differentiation. The company went from relatively no revenues to over $200 million in a very short period. The stock price appreciation in '03 reflected the product's potential in formula as well as within a much larger market, the larger food products market. I foresaw some pending issues however, and I wrote about them in my reports as I downgraded the stock from a "strong buy" to a "buy". I noted that a company with little experience manufacturing product and with a talented, but relatively speaking, inexperienced management team, was likely to run into "growing pains". And they did... A blackout in Italy spoiled the only source of ARA, which Martek outsources. It lead to supply delays, angry customers and revenue and profit shortfalls. Then, a fire at a plant in the US, at the time a key to its production, again led to supply shortfalls. Then, due to customer frustration, the formula makers built up a safety stock of supply without notifying Martek, and this led to a revenue shortfall, again a negative surprise for investors. Finally, the company's efforts to gain new revenue streams were not moving as swiftly as the analyst community had forecast. The stock languished as investor sentiment turned sharply negative. So what's changed?Martek has insured its supply of ARA will not run short by contracting to produce if necessary on its own, while also convincing the supplier to produce domestically. Martek has built a new plant at a second location, insuring its own supply of DHA in the event of a production facility issue. More importantly, management is better overseeing its communication with the investment community, expressing its expectations in a more reserved manner. Thus, it has beaten EPS estimates on four consecutive occasions (I believe 5). This is effectively helping to again turn investor sentiment, but this time in a positive direction. Also aiding sentiment, is the flow of new food and infant formula product deals and partnerships being signed. The company has agreed with the likes of General Mills, Kellogg's, Coca Cola, Hains Celestial, and others to provide its DHA as an ingredient within their cereals, yogurt, soy milk and other products. Revenues from the food product segment are expected to "dwarf" the formula market. Also, the company expects its domestic formula customers to soon begin transitioning to a DHA inclusive product completely, which should help to take market penetration within the US from the 80s% up to near 100% in one quick swoop. International growth is accelerating as well within the formula market. Last quarter, the company exceeded estimates by 19% on the EPS line. All indications were that the company would exceed estimates and raise guidance again. I was somewhat concerned when the company did not raise guidance when they presented at a conference a few weeks ago, but I thought it was possible that the company's accounting department was not ready to state anything with confidence; this is likely with such a small company. Briefly, I believe valuation is greatly understated, as I expect a good deal of revenue and EPS contribution from food products in 2007. Even if estimates are correct, this stock is priced at a P/E of 23 FY 07 (Oct.) estimates while sporting a forecasted long term growth rate of 26%. So, at a PEG of 1 or lower, with growth I see above 35%, I love this stock more than any other long-term. Short term it continues to fluctuate with other high beta shares. In this regard, this is because it is a small company and revenues are low and highly dependent on a handful of customers. However, it is not a biotech stock in reality, but a food company. Yes, it is small, but over time I expect the stock's beta ratio to gravitate toward 1 or lower. It's a high growth food company, and those tend to perform well. It should also benefit from the pivot point turn in sentiment, moving from greatly under-appreciated to properly and eventually over-appreciated. These are the best kinds of investments, ones benefiting from growth potential, and greatly undervalued at the same time.
So that's the story, and here's why I view the disappointment in the management's guidance for FY Q4 October, and the resulting price drop, as possibly the last great buying opportunity for the shares. The shares were down a good $4 plus after hours and now more than $6, as the company provided revenue guidance 10% below Q3 and EPS guidance 25% short. The market saw this as a huge let down, and just another failure when Martek had us believing in it once again. However, we must devoid ourselves of these emotions that can influence our logical decision making. The CFO pointed out last quarter that this quarter might be impacted by customers' plant shutdowns for maintenance. Well, it seems he was off a quarter. Unfortunately, when it became clear there was not going to be a problem this quarter, the market assumed growth was so strong that there was not a problem at all. However, growth was strong because, I believe, a few important customers (or just one- Mead) acquired DHA/ARA inventory stockpiles ahead of their planned shutdowns, boosting the quarter's performance while impacting Q4. You see, they will not be buying in Q4 as they have already purchased supply. We need to understand that this is a very limited time issue, but it will happen the next time the customer does this, and the Martek management team needs to better manage the situation. However, it does not really affect the long term cash flow projections for Martek, and therefore, does not affect our valuation. Another thing of concern, was that Martek will reduce purchases of ARA from its supplier, as it does not need the inventory now. However, reduced purchases means higher pricing that will impact margins for a few quarters. My only question is this, why doesn't Martek have this same kind of pricing power with its own inconsistent purchasing clients. And why does it not have power with its supplier? Poor execution. But this does not dilute the revenue and earnings potential Martek still has in the food products segment, and should not dilute the stock price as much as it has today. So, I view this disappointing news as a driver for a bargain purchase of Martek shares. This is a long-term investment. Over the near-term, I cannot properly predict where the shares will go at this point. It could be a wild ride on Thursday and it could last through the week. But when it settles, I think it will be a bargain for the taking. It's only one product launch announcement away from a similar move, but up! That's the best buy, and its why you drive to the outlet mall. Why should your stock investment be any different than your clothing purchase. Buffet says buy when everyone else is heading for the hills. Well, that will be the case today. Good shopping to you.
posted by The Greek | 7:34 PM
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