Today’s stock is another specialized medical device company. It plays in the highly specialized market for organ transplant surveillance. It has all the attributes of a good stock—it’s expanding its end market potential with new products, is almost profitable, and the chart looks great!
Cabot Small Cap Confidential 236
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THE BIG IDEA
Fortunately, most people don’t ever have to think too seriously about donating an organ, or receiving an organ transplant. Perhaps they ponder it for a few moments when getting a new driver’s license. But that’s often as far as the thought process goes for most.
But there are roughly 2,600 heart transplants in the U.S. every year. Another 18,000 kidney transplants are performed. Globally, the number jumps considerably. And even in developed economies the number of transplanted organs is dwarfed by the number of people on waiting lists.
It’s estimated that well over 100,000 patients in the U.S. are awaiting a kidney transplant right this minute.
The emotional and financial cost of organ transplants is huge. I can’t even fathom the first. But it’s not hard to dig up data on the second.
My research shows a wide range in the cost of transplants on an individual patient level. But looking at averages, in the U.S. the average cost of a heart transplant seems to be around $1.4 million. A kidney transplant will run about $400,000. These figures include all the costs a month before the procedure, and about six months after the procedure.
The real “all in” figure over a longer time frame is much more for many patients. Most require lifelong surveillance of some sort. And sometimes a patient’s immune system rejects the new organ and another procedure is necessary. Medicare data suggests the median annual cost of care for a patient with post-transplant kidney failure, that is on dialysis, is five times higher than the cost for a patient with a functioning transplant.
We’re not going to solve the underlying reasons that lead to heart and kidney transplants in the near term. But newer technologies can make life better for those who do need, and receive, these organs.
One of the most fertile areas for innovation is post-transplant surveillance. The standard of care has been tissue biopsies, which are both expensive and invasive. And because multiple tissue samples are required in the first year after surgery the emotional and financial cost adds up quickly.
Today, there’s a new batch of non-invasive surveillance systems that don’t create new risks for the patient, are easy to complete, accurately detect organ rejection early and are able to be completed, at reasonable cost, on a regular basis.
These tests also allow immunosuppression therapies to be personalized based on an individual’s specific needs.
As you likely suspect the company making all this happen is this month’s Cabot Small-Cap Confidential candidate.
It’s not only come up with a better system for organ transplant surveillance, it’s growing revenue quickly, just turned cash flow positive, and is likely to turn its first annual profit in 2019.
THE COMPANY/PRODUCT
CareDx (CDNA) is applying the latest advancements in genomics and bioinformatics technology to improve the lives of organ transplant patients. It specializes in noninvasive diagnostics solutions for heart and kidney transplants.
Care of organ transplant patients, both before and after surgery, is a hands-on and expensive endeavor. And it requires specialized life-long surveillance from highly-trained healthcare providers. CareDx’s solutions help these clinicians perform surveillance and risk assessment so they can better individualize immunosuppression therapy and reduce the use of invasive and expensive biopsies, which require tissue samples taken from a transplanted organ.
Its first commercialized test, AlloMap, is a post-surgery heart transplant molecular test. It launched in 2005. Today, AlloMap is used at around 125 of the 141 heart transplant centers in the U.S. and has an estimated addressable market of $150 million.
In 2017 CareDx launched AlloSure, a donor-derived cell free DNA (dd-cfDNA) test for kidney transplant patients. Just 12 months post launch CareDx has provided AlloSure to over 4,000 patients, representing roughly 2% of the U.S. kidney transplant patient population. This is a big potential market that’s likely to surpass $2 billion.
CareDx also offers a range of pre-transplant diagnostic solutions that help match organ donors and recipients. It is expanding market potential by introducing new solutions and management estimates the total addressable market is currently around $500 million.
CareDx is off to a good start. But with tens of thousands of patients around the world still waiting for heart and kidney transplants, and all of them needing pre-transplant matching and post-transplant surveillance, there is a lot of work left to be done.
The company is based in Brisbane, California and also has significant operations in Stockholm, Sweden. It was founded in 1998 and went public in 2014. Among its early investors is the genomic sequencing giant Illumina (ILMN), which invested in CareDx before the launch of Illumina’s venture capital fund in 2017. CareDx currently has a market cap of $1 billion.
Revenue was up 19% in 2017 and, according to preliminary results released this morning, was up 58%, to just over $76 million, in 2018. The vast majority of revenue comes from the U.S. and Europe and growth is being driven by AlloSure and pre-transplant solutions. CareDx is not yet profitable, but should be in 2019. After an equity offering in late-2018 CareDx is debt free.
A Crash Course in Organ Transplant Surveillance
Historically, the heart transplant surveillance standard has been the examination of heart tissue obtained through an invasive endomyocardial biopsy. To obtain the tissue a catheter is inserted through the right internal jugular vein via the patient’s neck and routed into the right ventricle of the heart. Four pieces of tissue are cut from the heart wall and sent to a lab where a pathologist looks for evidence of cellular rejection.
Suffice to say the procedure isn’t one anybody looks forward to. The typical post-transplant biopsy schedule involves eight to 10 biopsies within the first six months and up to 15 within the first year. The cumulative cost, trauma to the heart, and to a patient’s psyche, is significant. Plus, there is potential for subjective pathologist evaluation, tissue sampling errors and damage to the valve structures of the heart.
In the case of a kidney transplant the general idea is the same. Biopsies are often completed with the use of specialized needles, guided by ultrasound, that take tiny samples of kidney tissue. Because these procedures are relatively invasive (but an outpatient procedure with local anesthetic only) the industry has begun to move toward surveillance of serum creatinine levels, which can be obtained by taking a blood sample.
A jump in serum creatinine levels can indicate diminished kidney function, but it can be a lagging indicator and doesn’t give the entire picture, so periodic biopsies are still necessary.
With both heart and kidney transplant procedures, immunosuppressive drugs are typically used to treat and prevent organ rejection. Biopsy schedule decreases after the first year because of discomfort, cost, inconvenience and lower risk of finding issues. But issues do pop up and patients are usually on immunosuppressive drugs for the rest of their lives.
Lacking current data on a patient’s unique immune system and its response to the new organ in the months and years following transplant, physicians are often forced to adopt a “one-size-fits-all” drug dosing approach.
That’s not ideal. It makes much more sense to match up continuous drug doses with what an individual actually needs. CareDx’s AlloMap and AlloSure solutions allow clinicians to do this, while reducing the need for invasive biopsies.
Products, Services and Major Studies
Post-Transplant Surveillance
AlloMap
AlloMap is a non-invasive heart transplant molecular blood test than can be used 55 days after surgery. It is a gene expression test that measures the molecular signatures that can tip clinicians off to acute cellular rejection, well before evidence of damage is visible from a tissue biopsy sample.
The test protocol goes like this: A clinician orders AlloMap, which triggers a blood sample from the organ recipient. That blood is processed to isolate the white blood cells, which are then broken down, frozen, and sent via overnight courier to CareDx’s lab. Results are sent back to the clinician within two business days of CareDx receiving the sample.
The test looks at 20 genes (11 informative, 9 for quality control) and yields a single AlloMap score ranging from 0 to 40. This score has negative predictive value (NPV), meaning it determines the probability of the absence of moderate to severe acute cellular rejection (ACR). In other words, it tells clinicians what the chances are that a heart transplant recipient will not reject the organ. If a test score is below a certain threshold surveillance biopsy is not necessary. Above that threshold, a biopsy may be ordered to gather more information.
AlloMap Score Variability (AMV), is an additional service that is based on the variability of AlloMap scores and can offer predictive insights into risky future adverse events, such as death, re-transplantation or graft heart failure.
AlloMap launched in January 2005 and well over 110,000 tests have been performed to date, including more than 16,000 in 2018, when over 130 of the roughly 137 heart transplant management centers used AlloMap. The test has received positive coverage from many of the big U.S. private players (Aetna, Anthem, Cigna, Humana, etc.). It is also covered by Medicare and in 2018 CareDx benefitted from a 14% increase, to $3,2240, in AlloMap’s reimbursement rate.
The big studies that helped AlloMap get where it is today are the CARGO (Cardiac Transplanted Organ Rejection Gene Expression Observational) analytical and clinical validity study, published in American Journal of Transplantation in 2006, and the IMAGE (Invasive Monitoring Attenuation Through Gene Expression) clinical utility trial, the results of which were published in the New England Journal of Medicine in 2010.
HeartCare
HeartCare is the next iteration of AlloMap (it launched last April) and should help keep the product growing at roughly a mid-single-digit rate. It’s a surveillance solution to help clinicians better monitor heart transplant recipients for allograft rejection. It gives information about heart transplant recipient immune activity and donor graft injury using both the AlloMap (gene expression profile-based measure of host immune activity and risk of acute rejection) and AlloSure-Heart (dd-cfDNA analysis to monitor graft injury) solutions. These combined technologies give robust information about biological process, including immune quiescence, active injury Acute Cellular Rejection (ACR) and Antibody Mediated Rejection (AMR).
Surveillance HeartCare Outcome Registry (SHORE)
CareDx launched SHORE in September 2018. It is a prospective, multi-center, observational, registry of patients receiving HeartCare surveillance. The company says initial interest from transplant cardiologists is high and that SHORE’s design derived from previous experience from the OAR and D-OAR registries, which included 35 centers and over 2,200 patients. The primary outcome measure is percentage of patients alive at one, two and three years, post-transplantation.
AlloSure
AlloSure is a first-of-its-kind non-invasive blood test that accurately detects active rejection of a transplanted kidney. The test uses proprietary next generation sequencing (NGS) to measure donor-derived cell-free DNA (dd-cfDNA), which is fragmented DNA in the bloodstream coming from injured and/or dying cells in the donor kidney (or heart, in the case of AlloSure-Heart).
Because higher levels of dd-cfDNA in the blood appear to be a clear biomarker AlloSure helps healthcare providers and patients better manage long-term care following a kidney transplant. The test also helps determine levels of immunosuppressants.
The testing protocol is similar to that of AlloMap. First the test is ordered by a clinician, triggering a blood sample, which is then sent overnight at ambient temperature to CareDx’s lab. Cell-free DNA is purified from the plasma and the amount received from the organ transplant is figured as an overall percentage of dd-cfDNA. Results are sent back within three days of sample receipt.
In October 2017 AlloSure became available for commercial testing with Medicare coverage and reimbursement. The current reimbursement rate of $2,841 was well ahead of analyst expectations and implies the product could bring in revenue of roughly $200 million a year. No positive coverage from private players is yet available, but AlloSure has received payments on a case-by-case basis. This early in the launch it’s not surprising that there isn’t any commercial coverage yet. As volumes increase in 2019 CareDx management expects to start talking with payers about reimbursement rates.
AlloSure has been ordered by 100 kidney transplant centers in the U.S. and in 2018 over 11,000 test results were completed. Not all of these centers are high-volume orders (10% to 20% are) and there will be some variability in order flow over time as centers determine what their particular testing protocol will be.
Kidney Allogaft Outcomes AlloSure Registry (K-OAR)
CareDx initiated the Kidney Allograft Outcomes AlloSure Registry (K-OAR) study in 2018 to gather more data on the clinical utility of AlloSure for surveillance of kidney transplants. This study will help establish standard surveillance monitoring protocol for kidney transplant patients, which will help drive recurring revenue from surveillance testing. K-OAR is included in Medicare coverage and CareDx as of the end of Q4 2018 the company had enrolled 748 of its expected 1000 patients at 47 of the 50 centers it expects will ultimately participate as K-OAR sites. I’ll update you on progress as this study moves along.
Blood for Diagnosing Acute Rejection in Kidney Transplant Recipients (DART)
The largest body of clinical evidence gathered to date for AlloSure is from the dd-cfDNA in Blood for Diagnosing Acute Rejection in Kidney Transplant Recipients (DART) trial, which is sponsored by CareDx. The trial ran from April 2015 through January 2018 at 14 centers where blood specimens were periodically drawn from 384 patients for up to 24 months (2109 patient visits in all). The results showed the test was more effective than scrum creatinine values in translating higher levels of dd-cfDNA into active rejection of a kidney transplant. CareDx plans to update the market on more data insights from this trial as it is analyzed.
Pre-Transplant Diagnostics
With the acquisition of Allenex in 2016, CareDx began making and selling products that improve the odds of successful transplants by better matching a donor with a recipient of stem cells and organs. Allenex’s portfolio included Olerup SSP, which is used to type Human Leukocyte Antigen (HLA) alleles based on sequence-specific primer (SSP) technology. Olerup QTYPE is another HLA typing product, which uses real-time polymerase chain reaction (PCR) methodology.
With the 2017 acquisition of Conexio (purchased from Illumina), CareDx now also offers a complete product range for sequence-based typing (SBT) of alleles, including Olerup SBT (test kit) and Assign SBT (companion software). The Olerup franchise has been the distributor of Conexio’s SBT product line since 2011 so this acquisition, from strategic investor Illumina, made a lot of sense.
CareDx worked with Illumina on another significant deal in the middle of last year. Beginning in June 2018 CareDx became the exclusive worldwide distributor of Illumina’s TruSight HLA Sequencing Panels and related software for use in bone marrow and solid organ transplantation diagnostic testing. The company also has the exclusive right to develop and commercialize additional transplant next-generation sequencing (NGS) products using Illumina’s platform.
These future products will be branded as AlloSeq HLA (transplant matching), AlloSeq BMT (simplified workflow and automated analysis for chimerism testing, used in bone marrow transplant) and AlloSeq cfDNA (measurement of cell-free DNA associated with allograft injury), and they are slated to launch this year. Altogether, these products should help CareDx expand its product lineup, address new markets, including bone marrow transplant, and continue to meet its goal of improving transplant patient care.
As part of the deal CareDx made a one-time $5 million payment, will pay royalties (mid-single- to low-double-digit percentage) on sales of any commercialized products and agreed to minimum purchase commitments from Illumina through 2023.
CareDx’s pre-transplant products are distributed in many areas around the world and represent roughly 20% of total revenue.
The Business Model
CareDx sells noninvasive diagnostics solutions to help match donors and recipients both before and after heart and kidney transplant. The business model is driven by growth in pre-transplant product revenue (roughly 20% of sales) and recurring, post-transplant testing services revenue (roughly 80% of sales). As testing volume grows, along with reimbursement rates, the company’s gross margin improves.
For post-transplant solutions CareDx has a direct field team of around 27 people that handle sales, marketing, medical science liaison, managed care and patient care management reps. For pre-transplant solutions it has a field team of 21 people (beginning of 2018) and sales offices in Vienna, Austria, Stockholm, Sweden, West Chester Pennsylvania, U.S. and Fremantle, Australia.
In terms of testing equipment CareDx relies on just a few suppliers for lab equipment and reagents for AlloMap and AlloSure testing, including Thermo Fisher Scientific, Fluidigm, Illumina, Becton, Dickinson, and Streck, Therapak/Quigen N.V. In many cases CareDx is reliant on a single source for a particular reagent as it was part of a solution’s FDA approval.
For testing AlloMap in Europe CareDx has contracted with Diaxonhit, its European commercial partner, for testing at a dedicated lab in France. This arrangement has been in place since 2016.
The Bottom Line
CareDx grew revenue by 44% in 2016 and 16% in 2017. With the launch of AlloSure in October 2017 revenue began to accelerate again, growing by 21% in Q1 2018, 48% in Q2 2018, 74% in Q3 2018 and an estimated 86%, to $23.3 million, in Q4 2018 (based on preliminary results).
AlloSure is the biggest driver of growth and helped power roughly 115% year-over-year growth in testing services revenue. Management says that at year end 100 transplant centers – representing roughly 60% of transplant volume in the U.S. – had provided AlloSure results to patients since launch.
The company provided 4,575 AlloSure patient results in Q4 to roughly 3,377 kidney transplant patients. Preliminary results didn’t give the new number of standing order patients, which stood at 2,736 at the end of Q3, when 1,260 new standing order patients were added. A standing order patient is one that will follow the surveillance protocol, which is being established by the K-OAR study, for at least a year. These patients drive consistent recurring revenue.
AlloMap test volume was up 6% to 4,080 patient results in Q3 and another 4,057 tests were completed in Q4. With the HeartCare launch (combines AlloMap and AlloSure-Heart) in April the solution was available throughout all of Q3 and Q4 and is part of the overall strategy to help drive mid-single-digit growth in AlloMap. We don’t yet have an update on HeartCare in Q4 2018.
Sales of transplant lab products was up 24% to $4.6 million in Q4 2018, a big acceleration from 9% growth in Q3 and 5% in Q2, most likely due to the addition of QTYPE and TruSight HLA sequencing panels, and the October launch of AlloSeq HLA, AlloSeq cfDNA and AlloSeq BMT. We’ll get a better sense of how these products are doing on an individual basis when official Q4 results come out in March.
Full-year preliminary revenue for 2018 came in at $76.2 million to $76.5 million, an increase of 58%. Back on the Q3 conference call (November 8) management was asked about 2019, and while it wasn’t willing to give official guidance it said it felt “very confident” in its ability to hit a previously issued aspirational goal of $90 million to $100 million in revenue. That implies a 25% growth rate, but based on preliminary Q4 results it seems CareDx should do far better. We’ll get updated 2019 guidance in March.
The company is not yet profitable, but did generate positive operating cash flow ($400,000) and positive adjusted EBITDA ($200,000) in Q3 2018, one quarter ahead of expectations. Management said it will be making modest investment increases in marketing and sales but is still looking at positive adjusted EBITDA for the full year 2018. Consensus estimates are calling for an EPS loss of -$0.18 in 2018 (a 74% improvement over 2017) and a breakthrough to profitability in 2019, when EPS could hit $0.16. Based on preliminary 2018 results I think EPS should come in ahead of expectations.
At the end of 2018 the company had $64.6 million in cash and cash equivalents. This reflects the leftover cash after a November 2018 equity offering, and payoff of $15 million in debt soon thereafter.
RISK
Reimbursement Rates: All medical device companies are subject to pricing risk related to Medicare reimbursement, and reimbursement of private payers. Thus far CareDx’s reimbursement rate trend is positive, but rates aren’t out yet for 2019 and beyond. The stock is likely to react, both positively and negatively, to updates on reimbursement rates as they have a direct impact on revenue.
Reliance on Medicare: In 2017 Medicare revenue represented 40% of post-transplant testing revenue. The final results aren’t in for 2018 yet, but Medicare is sure to represent a good chunk of revenue again, and for the foreseeable future.
Reliance on AlloMap and AlloSure: AlloMap has historically been the driver of CareDx revenue. Now, and for the foreseeable future, AlloSure is the largest growth engine, along with expansion of the pre-transplant product portfolio. Any material disruption to any of these three areas of business could be materially negative for the stock.
Clinical Trial Risk: Any setback in AlloSure-related trials could hurt the test’s ability to fully penetrate its target market.
Loss-Making Company: CareDx has yet to turn a profit and just delivered its first quarter of positive operating cash flow and positive adjusted EBITDA in Q3 2018. Barring unforeseen negative events or significant investments, the company should start generating more positive cash flow in 2019 and be profitable (on an adjusted EPS basis). It also completed a secondary offering in late 2018 and paid off all its debt. However, CareDx is still a relatively young company and there’s no guarantee results will come in as expected and there won’t be dilutive secondary offerings in the future.
Adoption Trends: Biopsy and homegrown tests have historically represented the main competition for CareDx’s solutions. If there is any loss of confidence in the company’s products, or significant improvements in tissue sampling methods, the estimated addressable market for CareDx’s solutions could shrink.
Stock Volatility: CDNA has a beta of 1.4 which means it tends to move quite a bit more, both to the upside and the downside, than the broad market. You’ll notice significant daily price swings. Unless there is some significant news event it’s best not to get too concerned with these price swings.
COMPETITION
CareDx faces competition in both the pre-transplant HLA typing products and post-transplant surveillance diagnostic test markets. In the pre-transplant HLA tissue typing market the primary competitor and market leader is Thermo Fisher Scientific (TMO). In more specialty markets CareDx competes with Illumina (ILMN), Protrans, GenDx, Bio-Rad Laboratories (BIO), Immucor, as well as “home brew” testing solutions developed in-house by hospitals and commercial reference labs. In the post-transplant market, most competition comes from clinical reference labs and hospital labs that use internally developed and/or routine clinical chemistry tests and biopsies, which have been the standard of care in the U.S. for years.
THE STOCK
Trading Volume: CareDx has a market cap of $1 billion and trades an average of 710,000 shares daily. That means roughly $17.8 million worth of stock trades each day. Our subscriber group shouldn’t move this stock. Heavy days are +1 million shares, and that’s happened 10 days over the last six months.
Historical Price: The company went public on July 17, 2014 at 4 per share. It got off to a slow start and trended down for several years, ultimately trading just below 1 in 2017. It was back near 7 by the beginning of 2018, then retreated to near 5 by early spring. As results of the successful AlloSure launch came in momentum began to build, and CDNA hit 18 in mid-August. Its September closing high was a fraction below 30 and through the market turbulence of Q4 2018 the stock traded mostly in the 22 to 30 range, with a few short adventures above and below that range. The all-time high of 30.8 was struck in early December, and was followed soon after by a quick spike down to 19.11 just before Christmas, which was just above CDNA’s 200-day moving average line. Since then the stock has recovered to near 25, which is just below its 50-day moving average line.
Valuation & Projected Price Target: Shares of CDNA trade with a 2019 EV/Sales multiple of 9 based on estimated revenue near the high end of management’s aspirational goal of $100 million. The stock has traded up to an EV/Sales multiple closer to 15, which implies it could trade up roughly 50% before it surpasses peak valuation. Provided Q4 results come in as expected and management issues preliminary 2019 guidance near expectations I think the stock could easily climb 50% from its current price in 2019. Therefore, my 12-month price target is around 37.
Buy Range (next two months): My wide preferred buy range is between 21 and 28. The low end of this range is about 16% below where CDNA closed last Friday and the high end is about 12% higher. In the Cabot Small-Cap Confidential portfolio we will take a full position at today’s price to help simplify our portfolio tracking results (which have gotten a little more complex with partial positions in recent months). But as always, I strongly recommend you average in to spread out your cost basis.
The Next Event: Management announced preliminary Q4 2018 results early this morning. It is expected to announce official Q4 2018 results and 2019 guidance on its official earnings call in March.
CareDx (CDNA) Financials
CareDx (CDNA) |
UPDATES ON CURRENT RECOMMENDATIONS
Due to the nature of the stocks recommended, it is to your advantage not to share these recommendations.
The Weekly Update segment of this month’s issue was sent out on Friday, January 4th.
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Next Cabot Small-Cap Confidential issue is scheduled for February 1, 2019
Cabot Small-Cap Confidential is published by the Cabot Wealth Network, an independent publisher of investment advice. Neither the corporation nor its employees are compensated in any way by the companies whose stocks we recommend. Sources of information are believed to be reliable, but they are in no way guaranteed to be complete or without error. Recommendations, opinions or suggestions are given with the understanding that subscribers acting on information assume all risks involved. Copyright © 2019 - COPYING AND/OR ELECTRONIC TRANSMISSION OF THIS NEWSLETTER IS A VIOLATION OF THE U.S. COPYRIGHT LAW. For the protection of our subscribers, if copyright laws are violated by any subscriber, the subscription will be terminated.
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