Biostar Pharmaceuticals (BSPM) has recently applied for a Nasdaq listing and could be a double or triple once it trades on the Nasdaq.If you happened to have perfect timing during the worst financial crisis since the great depression and bought shares of Bristol Meyers ( BMY) you would now be up by 50%, and that is with the stock currently trading near a 52-week high. That is the absolute best you could do. Shares of Lilly ( LLY), Pfizer ( PFE) and Merck ( MRK) delivered near identical returns. Had you simply bought the Dow, you would be up by more than that 60%, and in fact if you had simply thrown darts at a board to pick your stocks you would likely have made a greater return. The fact of the matter is that big cap pharma is safe and boring and doesn't go up or down. It is nearly impossible to earn a significant return. As a result, I avoid putting money into big-cap pharma because it is too stable. For the opposite reason, I avoid putting money into biotech stocks. Money losing biotech stocks more resemble a trip to the casino than they do an investment decision. So what is the best way to play if you want to be invested in the healthcare and pharma space? The answer is small-cap, profitable fast growing drug makers and service providers in the pharma space. Take for example Wuxi Pharmaceuticals ( WX). The stock is up by nearly 400% from its lows last year, despite the fact that it was always highly profitable as well as having a strong balance sheet and positive cash flow. The stock traded below $4 and now trades above $15. The point is that you can find multi-bagger returns from stocks that have a very safe profile but you have to find them yourself because by the time they are making headlines the bargain will certainly have passed. The big question is now that the worst of the financial crisis seems to be behind us, are there still buying opportunities that can provide upside of several hundred percent? The answer is yes, but they are hard to find.
The best small-cap pharma stock I have found is Biostar ( BSPM), which has a market cap of approximately $100 million. From a growth and fundamentals standpoint the stock is stellar. But of equal importance, the stock has been beaten down to very cheap levels due to investors' misunderstanding of recent financial results. I recently bought the stock because I think these current low levels are unsustainably cheap and Biostar has the potential for a significant pop in the very near term. Before buying, I addressed three questions: What does Biostar do? Why is the stock so undervalued? What is the catalyst for the stock to move upward? Biostar's main product is Xin Aoxing Oleanolic Acid Capsules, a very cheap and effective treatment for chronic hepatitis B. The company has the only approved OTC product in China, a country where hepatitis B is a massive problem. The extent of this problem and the size of the population in China create a massive opportunity for Biostar. From a financial perspective, Biostar's performance is compelling. 2009 revenues grew 57% to over $53 million. Gross profit increased by over 90% and net income increased by approximately 57% to over $10 million. That would put Biostar on a trailing P/E of only 8-9x at current prices. But of much greater significance, Biostar recently issued its 2010 guidance, projecting net income of $18-20 million. This places Biostar on a forward P/E of only 4.5x, for a company with high growth, huge margins and a current ratio of 5:1. In fact right now the company trades at only 2x book value. In short, from a financial perspective Biostar is a no brainer at current prices. But if Biostar is such a great opportunity, then why does it trade so cheaply? First, Biostar is not yet listed on the Nasdaq and so it lacks a strong institutional following. However the company has already implemented all of the corporate governance measures required to list on the Nasdaq and has already applied to the Nasdaq for listing. The only thing I can see holding Biostar back from a Nasdaq listing is the share price, which must have a closing bid price above $4 for seven consecutive days in order to meet Nasdaq requirements. Given the current undervalued state of the company, and a share price hovering around the $4 mark, I see this as being no problem in the near future.
And the most significant reason for overhang on the shares comes from the company's recent conference call. In response to an investor question, the company responded that they did not rule out the possibility of issuing equity in 2010 in case any potential acquisitions came up. This has put a temporary cap on the stock price which creates a tremendous buying opportunity. After speaking with the CFO I decided to invest in Biostar, strongly betting that they will not issue equity in the near term or at these current depressed prices. First, the company is on the verge of uplisting. It should very soon be able to issue equity in the $8-10 range, not in the $4 range. An equity issuance would clearly hinder the uplisting and management would be unlikely to do this no matter how attractive the acquisition. Second, I confirmed with the CFO Elaine Zhao that the company has adequate working capital to operate the business without raising any money at all, and the only reason to raise money would be if an acquisition came along. Third, Biostar just completed an acquisition which they are currently in the process of integrating. It would not make sense for the company to feel compelled to issue equity at very depressed prices to rush into another acquisition before the first one was fully integrated. Finally, in speaking with the CFO it is clear that the company does not have any acquisition targets currently identified. In other words, this current overhang is likely unjustified and creates a great buying opportunity. Had the company been clearer on this issue on the conference call, I think the stock would have rebounded strongly and would now be in the $4.50-$5 range. The reason I bought Biostar is that once the share price stabilizes above $4 the uplisting should come quickly. In fact the $4 level is somewhat of a self fulfilling prophecy for the uplisting. To be specific, Nasdaq requires a closing BID price above $4 for seven consecutive days, it is not based off of the closing price. I spoke with the CFO and she confirmed that Biostar has already applied for listing and meets all of the corporate governance requirements including having the required number of independent board members. Once it trades on the Nasdaq, I would expect Biostar to trade on a P/E of at least 10x vs. 2010 numbers. Earnings for 2010 are projected at $18 million to $20 million. In the short term, I think a price of $8-$10 is more likely. That is a return profile roughly equivalent to how Wuxi has done over the past year, and is not unachievable. In the meantime, buying Biostar at prices below $5 is a gift that will not likely last very long.
Earlier this year the stock traded as high as $4.75, but that was before Biostar had even given 2010 guidance of doubling net income, so at current around $4 the recent developments with stock are clearly being overlooked. Other pharma stocks where I did some analysis but chose to not invest include Lotus Pharmaceutical ( LTUS.OB), TongjiTang Chinese Medicines ( TCM), American Oriental Bioengineering ( AOB)and Tianyin Pharmaceutical ( TPI). For Lotus, the numbers look cheap if doing a basic stock screen, but a further read into all of their filings and disclosure makes it clear that this is one to avoid. AOB and Tianyin both merit a further look, but there I currently see no compelling valuation motivation to buy the stocks. I will continue to watch those two further. Disclosure: The author is long shares of BSPM The author can be reached at firstname.lastname@example.org