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Seeking Alpha

Wednesday, December 12, 2007

Martek (Nasdaq: MATK) Earnings Preview


(Stocks in this article: Nasdaq: MATK, NYSE: ABT)

One of my favorite turn-around stories, Martek Biosciences (Nasdaq: MATK), a name I followed as an analyst, has gotten cheaper, and mostly on general market turmoil. With the company set to report earnings at the end of the day today, the report could offer an opportune catalyst for the stock this week. In any event, I like the shares over the long-term.

At the conclusion of my article on October 13, 2007, “Riding the Martek Roller Coaster,” I wrote, “we view MATK attractive now for picking at, and would certainly look to add shares on any broad market weakness.” Broader market weakness has in fact played a role in Martek’s shares’ decline off its high. Keeping risk in mind, we have to ask, is there good reason for this decline that might be related to systematic risk, and what other reason might exist. I believe there is some risk, because if consumers are constrained and food prices are generally high, it may matter less to a good many price-sensitive shoppers whether there is healthy for your heart lifesDHA™ in their food or not. They will not pay up for it at some threshold price level.

However, I do not think the economic situation has progressed enough to significantly impact the health pay-up purchase, and more importantly, Martek is making great inroads in a good deal of food categories and with new business partners. Still, analysts are becoming challenged to understand the importance of price versus the opportunity available in the food products category. For now I expect the existing trend of food products penetration growth will prevail in driving operational results, as the opportunity remains significant and relatively untapped.

The shares currently trade at about 30X the $0.86 consensus EPS estimate for FY 08 (Oct.). Analysts have yet to revise long-term EPS growth forecasts much, and still look for a five-year rate of 18%. However, growth in FY 08 is seen at 36.5%. I continue to expect earnings growth to exceed expectations, and project a 25% three-year rate. Applying my estimate, MATK’s P/E-to-growth rate ratio amounts to 1.2X, which I view as very cheap for a healthy growth story. The opportunity exists here because the market has yet to buy into MATK as a reliable growth idea. Investors still get antsy around earnings report time. However, my feeling is that the company has finally gotten the reigns on its horse, or rather control of it.

Over the last few months, the news from the company has been mostly of the favorable variety. Business operations seem to be progressing in many facets. Martek just penned a deal with baby food maker Beech-Nut to offer baby food products including lifesDHA ™. This is the natural extension from baby food that should have happened long ago, in my opinion. Mothers first become aware of the importance of DHA while taking prenatal vitamins or when learning about infant formula offerings. Therefore, they are likely to continue seeking it for their child when they go shopping for solid baby food. I think this deal and others like it could play a role in a potentially improved FY 08 outlook offered by the company. Analysts have not made much change, while adjusting FY 08 estimates up $0.02 in the last 30 days.

The company also came out victorious in several patent infringement cases, settled several lawsuits and also better insured stability of business when patents run out. In that regard, Martek entered into a long-term sole source deal with Abbott Laboratories (NYSE: ABT), where Martek will exclusively provide its additive to Abbott Nutrition’s Similac Advanced brand of infant formula. Two-thirds of the company’s infant formula market is now under long-term contract.

The company’s recent class action settlement is to be fully covered by Martek’s insurer, so we should not see an impact from that. The company’s recent settlement with OmegaTech shareholders requires the company to issue another 341K shares (about 1.1% of shares outstanding according to Yahoo! Finance) and recognize roughly $10 million of goodwill upon issuance. I view this as relatively insignificant to ongoing operations outside of minimal share dilution.

I’ll sum up my opinion like this: any time you have to pay something you might not otherwise have needed to, it means less capital is available for other uses and that’s bad. Still, in using shares, the company mitigated that capital constraint somewhat, or rather shifted the burden to shareholders. However, the dilution impact appears minimal and not significant to the valuation of ongoing operations and those related cash flows. Thus, if news of a small impact to FY 08 does affect the stock price in the future, I would view it as a buying opportunity. And let’s not forget that in exchange for that compensation, Martek acquired important strategic assets and rights.

Finally, the company recently took part in a ThinkEquity Partners conference, something I’m not sure they would have done if they had a very horrible skeleton to report on Wednesday. There are no guarantees of anything in life, but even if some unforeseen news frightens investors, MATK would become an even more attractive buy in my eyes, and remains a stock I like for ‘08. Risk caveats aside, I would own MATK for the long-term based on my favorable view of its valuation and product opportunity.

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Mmm....a relaxing spa day!

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