Kancera - Big gains but what are investors really getting for their money?

Kancera is a small biotech company traded on the NASDAQ OMX North that focuses on new medicines for the treatment of cancer homepage. Before I dig any deeper into the company and science I'm going to show a chart of the share price to show what massive gains this stock has had.

The mind boggling numbers can be summarised as follows

• 12 months +954%
• 3 months +375%
• 1 month +198%
• 1 week 144% (!)

It currently trades at a market cap of 773 MSEK ($108.3m) and P/B 22.9. It goes without saying that it has negative earnings, due to current investments in R&D.

I think it's fair to say this is a popular stock and probably attracting lot of speculative money, or worse people who think they are making fair investment but are not. We shall hopefully find out. So what are Kancera actually doing science wise? They have three ongoing projects in their research portfolio, which focus on cancer

• A ROR inhibitor described as follows

".....which can reprogram cancer to make it destroy itself. ROR inhibitors have been shown in the laboratory to be effective against both solid tumors and leukaemia."

The strategy has modified lately in which they plan to combine it with a ROR vaccine.

"Kancera´s strategy is to use its future small-molecule ROR inhibitors as a first line treatment for the disease to remove the main part of the tumor and the symptoms, and thereafter follow with a prophylactic ROR vaccine to prevent relapse. Thus, there are possible synergies between Kancera´s small molecule products and the vaccine against ROR."

• Small molecule PFKFB inhibitors 

".....substances capable of making cancer more susceptible to chemotherapy by modifying cancer cell metabolism in solid tumors using what are known as PFKFB inhibitors."

• Small molecule HDAC inhibitors

".......drugs aimed primarily at neutralizing leukemia by inhibiting epigenetic processes, such as those that control gene activity."

Sounds exciting, new drugs will always be welcome and needed in treating patients with cancer. The strategy seems to be to take these new treatments to a pre-clinical stage at which point they would partner with large or mid pharma who would have the competencies and assests in place to start the clinical trials. This makes sense, these trials can cost a lot of money and is a typical strategy for small biotech's.

We need to take a look at the latest 2014 Q2 report to get an idea at what stage these projects are at.

"Kancera has reported results from the collaboration on PFKFB3 inhibitors with Professor Thomas Helleday at the Science for Life Laboratory which was initiated in 2013. Within the framework of the collaboration a large-scale laboratory evaluation of synergistic effects between Kancera’s PFKFB3 inhibitors and a large number of approved drugs has been performed. The results show that synergistic effect against cancer cells can be achieved by combining PFKFB3 inhibitors and some defined classes of approved drugs. In light of the present results, new experiments are planned using preclinical disease models to verify whether PFKFB3 inhibitors can improve the treatment of advanced lung cancer and metastatic breast cancer."

Certainly promising results in proving how their PFKFB3 inhibitors can treat cancer but we are talking mid to early stage research here. It is possible to watch an interesting presentation by Thomas Olin VD here from the start of the year. From that I take these are experiments to prove a role of the target but they need to do more research to improve the inhibitors as drugs.

Next we have the HDAC inhibitors which also seem to be at early stage research

"Kancera hereby announces that the development of the HDAC6 inhibitors are progressing faster than previously estimated in the second quarter when HDAC6 inhibitors were developed that are more potent against cancer cells than Acetylon´s ACY-1215 and also better tolerated by healthy human blood cells."

Again promising results and I wish them every success but we are a long long way from a clinical candidate. If all it took was to treat cancer cells in a laboratory then cancer would have been cured a long time ago. There are still many challenges to go. It's difficult to put a probability of success on these projects, they could potentially never get beyond the early research stage. It happens all the time.

As an investor I think you are paying for what I would call 'optionality' with these projects. It's possible to loose everything but huge upside if the small probability event goes your way.

I would say their ROR project is the flagship of the portfolio and seems more developed than the others.

"Kancera hereby announces that animal studies are proceeding according to plan towards the selection of a candidate drug in Q3. The results so far support that an effective concentration of the ROR inhibitor can be achieved in cancer cells for long enough to reach the desired anti-cancer effect. Animal studies are currently being conducted in order to assess efficacy and safety, why risks in the development of the drug candidate in the ROR project remains."

This is more like it, we are now getting much closer to a clinical candidate that they hope to partner with established pharma in the future. It sounds like they are achieving the desired concentration of drug in the system, which is good of course, but no news as yet if it has any effect. This will come I assume after the end of the study.

A word of caution this still does not mean the desired effect will occur. There are 3 major likely outcomes - Nothing, cancer unaffected (the worst - what went wrong?), maybe the cancer shrinks but by not very much (then you have a debate on why?!) or the best scenario, it goes exactly to plan then it's full steam ahead!

These still doesn't address unexpected effects (good or bad) or a poor safety profile which may prevent further development of this particular substance tested. What will happen to the share price if this one animal study does not deliver to everyones hopes? This is a question that all serious investors must ask themselves. What is the downside risk or at least how do I limit it?

In terms of financial rewards Kancera point towards the deal done by Pharmacyclics and Johnson&Johnson for their new anti-cancer drug Ibrutinib. So far J&J have coughed up $150m in milestone payments and could pay out even more, another $825m (see presentation mentioned above and here)

Pharmacyclics is now valued as a $9bn company and trades at P/E 105, looking at their website they have the one drug launched. If Kancera matched that, then we are talking x83 fold move in share price from its current market cap, that though is a big 'if'!

To get a sense of perspective the success rate of cancer drugs from Phase 1 to launch has been recently shown to be about 10% here. From a preclinical stage the probability of success will be much smaller.

Kancera also cite a deal between Celgene and Agios who payed $120m plus royalties for rights to their phase 1 candidate drug AG-221. The stock jumped 28% or around $330m on the phase 1 results.

Interestingly the investor website aktieinvest attempted to make a valuation of Kancera back in March and concluded a market cap of between 123-539 MSEK if both the ROR and PFKFB3 projects received milestones in the coming years. The current share price is about 50% over the higher end. I won't go into the details here (in Swedish) but they use a previous deal between KaroBio and Pfizer as it's basis, look at the probabilities of reaching different stages and even the possibility of both drugs being launched as 'orphan designated drugs'.

What else on top of the projects mentioned are investors getting for their money when paying  for Kancera with market cap if 773MSEK? Not much is the answer.

• 33.8MSEK in equity (P/B 22.9)
• Of which 6MSEK is intangibles
• Patents covering current research
• -17.93MSEK in earnings
• 7.5 employees

Despite the interesting research and desirable goal of new cancer treatments Kancera stock cannot be seen anything more than a speculation and must be traded as so. There are high hopes by investors of huge gains on the launch of a new drug to treat cancer yet the probabilities of those gains are very low.

Of course things could work out very well for Kancera and stockholders will end up being very happy with the results, even if they buy at these levels. However, if you run across a motorway and survive doesn't mean it was prudent to do so!

Put Selling Opportunity: SCA

Svenska Cellulosa SCA is a Swedish company that is one of the worlds largest in personal care products (e.g. babies nappies), the third largest supplier of tissue (e.g. toilet and kitchen paper) and one of Europe's most profitable producers of forest products.

The current stock valuation is around P/E 17, EV/EBITDA 12 and it pays a 2.8% dividend which has been growing nicely since 2010. Below is a chart of the share price from the past year.

The stock reached a peak around 200 SEK back in Jan and has been steadily falling since then and is now close to its 52-week lows. If however, we go back 2 years we can see there was a big run up at the end of 2012 before consolidation around 160-165. 

This look an interesting area for selling puts in SCA. At this moment the October 165 put can be sold for around 2.15 SEK or the 160 put for 1.05 SEK. The choice depends on how happy the investor is happy in holding SCA stock if assigned (the latter of course being less likely).

If the stock falls to these strike prices then the puts could be bought back and then rolled out to the next month and down at the same time. For example this would mean buying back the Oct 160 put and selling the Nov 155 put. This then would put the strike price of the option below the consolidation zone mentioned before. If the stock price then stayed above 155, the put would expire worthless and the investor would keep all the premium. Further declines would require further rolling down of the puts and potentially other strategies to keep the trade profitable.

An alternative strategy would be to accept the shares and then immediately sell a covered call to bring in more income. For example if assigned shares at 165 SEK, 'at the money' calls with strike price 165 would be selling for around 2.75 SEK for a month out. Adding the premiums from the put and call would total 4.85 SEK giving a cost price for the shares of 155.15 SEK. The shares would then be called away if the price finished above 165 at the end for the month.

Put Selling Income: Sandvik

Selling puts is a excellent strategy for generating income and building capital. The key is to avoid speculative companies and focus on stabile large cap stocks that ideally pay a dividend. We're pretty much talking about the stocks that many investors find boring!

This is important because if you are ever 'put' the stock (i.e required to purchase shares at the strike price) you must have confidence to hold the stock and that the price will eventually recover so you will at least get your capital back. Large cap dividend payers don't usually disappear quickly and the dividend provides a cushion to your investment.

As it is, most options in Sweden are only available on large caps anyway so the temptation to bet on the twitters and facebooks of this world is not possible. For example Sandvik is a global engineering group that i) sells tools and equipment to the mining and constructions industries ii) is a world-leading developer and manufacturer of products made from advanced stainless steel grades and special alloys for the most demanding industries.

In the current rolling year it had 85000 MSEK ($12.4 billion) in revenue and made 4700 MSEK ($685M) in profits; although these are falling from 2012 highs which explains the stock price action. The company has a large exposure to the mining industry so business is being affected by the current downturn. It has a P/E 22 and pays a dividend yield of 4.1%. Expected profits for the year are 5.41 SEK per share giving a P/E 2014 16.6 at the current price of 85.4 SEK.

Below is a weekly chart of the share price over the past three years.

The price level of 80 SEK looks interesting; 5.8% below the current price. The stock last touched here in June 2013 before going sideways the past year between 85-95. Before that we have to go back to end of 2012 when Sandvik was selling at 80 SEK. 

Last week I was able to sell the Nov 80 put for 1.5 SEK. This means for every contract I sold (100 shares) I received 150 SEK but must be prepared, if assigned, to buy Sandvik stock at 80 SEK, costing 8000 SEK per contract, in the coming three months. This is a return of about 1.8% on my capital, 7.5% per annum.

It's not big money but I already have capital committed to other investments so instead of the usual goal of 1% per month I wanted a lower risk of assignment, so aimed for 0.5% return per month. However, the margin requirements to keep this trade open are roughly about 20% of the total (e.g. 0.2 * 8000 = 1600 per contract) increasing the return to a 'hypothetical 37.5%' per annum.

I say a 'hypothetical 37.5%' as it would be asking for big trouble to fully use the margin available all year round for these type of trades. A quick down turn in the market could mean being put a lot of stocks, more than you can afford and then a dreaded margin call.  Nevertheless the margin is available for use when required and comes interest free.

I have also decided to avoid being assigned Sandvik stock, I would rather use my capital for other investments, so if the stock price does reach 80 SEK, I will buy back the puts (most likely at a loss) then roll them down by reselling them at a lower strike price e.g. 77.5 SEK. I will also have to go further out in months to Dec or Jan to get my money back and keep the trade profitable.

The 'worst case' scenario is I unexpectedly get put stock early. I can either resell it and sell the puts as mentioned above or immediately sell covered calls to continue generating income. If the stock continues to fall I may have to apply more capital and/or other option strategies to get my money back and ideally still create a profit.

Cloning the cloner: Posco

"If there wasn’t a Warren Buffett, there wouldn’t be a Pabrai Funds… It is hard for me to overstate the influence Warren Buffett and Charlie Munger have had on my thinking… I can never repay my debt to them for selflessly sharing priceless wisdom over the decades." 

Mohnish Pabrai

Mohnish Pabrai is a fund manager I have followed a fair bit over the past years and who I think is very interesting in both his investing and life philosophy. He started an investment fund in the mid 90s after making money as an entrepreneur and he set out to copy Buffett in his value investing style and he even copied how Buffett initially set up the fee structure in his investment fund. He charges 25% for performance over the first 6%, so a 15% return on the fund would charge 2.25% (i.e. 0.25*(15%-6%))

His goal has always been to compound his wealth at 25% per annum, that's one hell of a target and he is pretty much on course for that. This even includes a severe downturn 2008-2009 where he openly says he compounded at minus 35% for a couple of years! In his own words 'I was handed my head on a plate'.

He has a modified his positioning strategy a bit from a 10*10 (ten stocks with 10% positions) to one where the more he is invested the higher the expected reruns must be. If I remember correctly the first 50% of the portfolio must be thought to return x2 fold, the next 20% x3 fold, the next 10% x4 fold. So to be 90-95% invested the investment must be expected to return x5 fold.

The idea is to avoid being fully invested in bear markets, unless there are very compelling ideas, as he was during the financial crisis. He was not able to buy stocks as they got cheaper and the problem was compounded by investors pulling money out of the fund. He found himself in the painful situation of being forced to sell when he wanted to buy more!

I can highly recommend his presentation videos that can be easily found on the internet. His most recent (but in my opinion not his best) was at google here. Another two which I enjoyed more are here and here.

His fund portfolio can be easily found on guru focus.com (for example) here. He hadn't added a new significant position since end of 2012 until now! I'd been waiting for this. The latest 13F for his fund for second quarter 2014 shows he has bought shares in Korean steel company Posco. The position is about 15% of his portfolio.

The following will be a brief outline of the company to try to understand his motivation for buying. I will not claim to have done a very deep analysis (I've actually just found more detailed analyses here by Swedish bloggers this year here and here).

To start with Posco (PXR) is a steel company that manufactures of hot rolled steels, steel plates, wire rods, cold rolled steels, galvanized steels, electrical galvanized steels, stainless steels, titanium products, magnesium products. However, it doesn't stop there, it's kind of an conglomerate that spans a trading business, commercial and residential property, operation of power plants and distribution of energy.

In Jan this year the ex-chief technology officer Kwon O-joon become the new CEO and he seems intent in ushering a new strategy of cutting down the debt (0.65 debt/equity ratio), increasing ROE and dismantling his predecessors 'empire' by selling off non-core assets here and here. This is a potential catalyst that Pabrai could be banking on, but that is speculation on my part. 

It didn't take too long to find out that Pabrai has followed Warren Buffet and Charlie Munger into this stock. Berkshire Hathaway bought about 4% back in 2007 here whereas Munger has invested about 4% of the investment portfolio at Daily Journal Corporation here and here. It's interesting to note that this portfolio only has 4 stocks in it; talk about a concentrated strategy!

That's think about that for a moment. Of all the stocks to choose from in the world, he has chosen just four - Wells Fargo 61%, Bank of America 30%, US Bancorp 5% and Posco 4%. That's a pretty strong ringing endorsement. I've not found at what price the shares were bought, but that should not really matter. Ideally the stocks you have in your portfolio should be the exact same ones you would buy if you started over and had cash.

A small glimpse of Munger's thinking can be seen here in the following quote back in 2007 at the Wesco annual meeting

"I would argue that what POSCO does is not a commodity business at all – it’s a high-tech business. They learned from Nippon Steel and they’re now even more advanced. I’d argue that if you have the most technologically advanced steel company in the world making unusual, [non-commodity] stuff, then business can be quite attractive for a long time."

If we look at some financials, it is not a pretty sight with shrinking margins as well as ROA and ROE which now sit at 1.4% and 2.9% respectively. It is not surprising to read that it trades below book value P/B 0.6. Historically the stock has typically traded around book value which is being suggested as a reason for potential upside in the stock. 

A quick check shows the book value of equity increased at an annual 12% from 2009 to 2013, so some value has been returned to shareholders over that period.

Posco has very little intangibles on it's balance sheet so trades below tangible book value at a ratio of 0.8. This is implying you could sell of all its hard asses such property and plant, pay off all its loans and still have cash left to pay equity holders at around $107 a share here. This of course assumes the book value of these assets is the same as their market value. I would need to check deeper, for example the depreciation and amortisation methodology. Equipment and plant could be less, especially in a forced sale but property could be worth a lot more. This also doesn't put any value on Posco's technology, R&D and in-house knowledge.

Oddly enough Posco's Q2 results are a mixed bag depending on which time frames are used. Earnings were down 20% and below expectations here when comparing to same quarter last year but nearly doubled compared to previous quarter here.

Interestingly Posco will also start to share in the profits from the Daewoo Myanmar gas fields, which will start to kick in this year at around $150M and next year at $300M here. This would represent about a 15% increase in the reported 2013 pre-tax profits. This could add a buffet to the income statement if the steel business continues to suffer.

On a final note, Pabrai has interestingly stated in a couple of videos (I'm paraphrasing here so I hope I don't misunderstand what he meant) that buying the best companies (e.g. lowest costs, best pricing power) in a struggling and consolidating industry can still end up a good investment. It's possible that's what he's thinking in this case. It is worth mentioning that Posco was recently voted the No. 1 competitive steelmaker in the world for the 5th year running here. 

In the interests of transparency I bought shares in Posco on Wednesday 13th Aug soon after reading the latest Pabrai fund 13F and doing a quick check on the company. One purpose of this blog article was to force me to go through the process of understudying the company better before deciding to buy any more shares.

Simple quantitative value: Sweden

This post is an update to a previous one called 'Swedish Value and Glamour Stocks'. This time I've expanded the stock universe to not only include large, medium and small caps but also First North which contains stocks of market values between 3100 MSEK to 1 MSEK (there is some overlap with the small cap universe). There are nows total of around 450 stocks in the list.

As before each stock is given a percentile score for the following value ratios P/E, P/S, P/B and dividend yield. Some values may be slightly different to before as first half years reports have now been released, so rolling sales and earnings have probably changed.

I've converted the P/E ratio to an 'earnings yield' and included stocks with negative earnings. Instead of giving them all a score of 0 I've ranked them in a way that the more negative the earnings yield the lower the score the stock gets in that category.

The scores from all categories are then added together to give an overall composite value which is used to rank the stocks. Below is a list of the stocks with the ten highest scores. 

As one would expect all have relatively low price ratios and give a decent dividend. The same usual suspects are there as before e.g. XANO, Acando, Doro but a few new ones have appeared due to the inclusion of First North list. Must admit I'd never heard of Precio Systemutveckling before, it's an IT  software and system management company.

Doro looks cheap

“What do you call a stock that’s down 90%? A stock that was down 80% and then got cut in half.”

David Einhorn

As a follow up to my blog post on 'Swedish Value and Glamour Stocks' I have now updated my list to also include EV/EBITDA in addition to P/E, P/S, P/B and dividend yield. The addition of this ratio to the composite does not change things so much, however the top 5 is shown below.

Although this type of investment strategy is usually applied by buying a diversified portfolio of the cheapest stocks, and not stock picking, I wanted to focus a little bit on Doro as it has now floated to the top of the list and I would say feels the most difficult to invest in of the five* (curiously the stock is up about 7% these past two days so the above figures are out by a bit).

Doro is a Swedish based company that develops and sells telecommunications products and software that is designed for the senior market. Products include mobile phones, cordless and corded phones, remote controls, alarm clocks and headsets.

I'm sure everyone must know an elderly relative who struggles to understand and use modern telephones, so I'm sure there is a market out there for simplified technology. However, one does wonder where the sustainable business model is, can't they just download an app onto a smart phone that simplifies the user software and shows big letters/numbers?

Anyhow, below is Doro's share price from the past two years, it has pretty much done a round trip from 25sek, up to 57sek and then back again to 30sek!

So what has happened the past year? Well the company has lost a lot if its growth from 2013, with lower sales, margins and weak cash flow (link analysis in Swedish) A company doesn't become cheap without good reasons!

So we know the latest financials are weak and have fallen below expectations, however it might be interesting at this point to (attempt to!) apply some Howard Marks' style of second level thinking (youtube and here) on Doro.

First level: Doro's fundamentals and growth have deteriorated; sell the stock.

Second level: Doro's fundamentals and growth have deteriorated, however the market has priced in too much bad news so the price has fallen too far compared to its fundamentals; buy the stock.

There is no magic or investment edge in the valuations shown in the table, the market sees the number too. Perhaps this is falling knife and we are far from the bottom.

However, what we do know is Mr Market is only prepared to pay this much for Doro's business and at the moment it's relatively little. Such stocks have a habit of surprising investors on the upside.

Apple: My Big Miss of 2013

“Forgetting your mistakes is a terrible error if you are trying to improve your cognition. Reality doesn’t remind you. Why not celebrate stupidities in both categories?” 

Charlie Munger

I'm sure Apple need no introduction, below is its stock chart from the past 2 years.

We can see the share price peak in Oct 2012 at just over $95 per share where Apple could do no wrong and was very popular with investors, attracting momentum traders. And why not, it had made people a lot of money and everyone liked their products.

Just six month later however, the share price had fallen 40% and found itself at $55 with worries of falling growth, shrinking margins and competition from the like of Samsung. Things would never be the same and Apples time had past. How quickly perceptions can change!

Those of you who follow Aswath Damodaran and read his blog Musings on Markets will know that he is a fan of Apple as a company and has regularity posted updates on his valuation of the company. He uses 'free cash flow to the firm' and discounts it to a present value to get a valuation of the stock.

In February 2013 with the share price at $440 ($63 at todays prices after 7:1 split) he wrote the following entry 'Back to Apple: Thoughts on value, proce and the confidence gap', discussing how, if at all, the share price would close the 38% to his valuation of $608.

What caught my attention was the following statement

"Thus, for Apple to be worth only $440 (or less), you would need negative or close to zero revenue growth, pre-tax operating margins of 25%(current margin is closer to 35%, down from 40% plus a year ago) and the cost of capital would have to be at 15% (the 97th percentile of US stocks)."

This was very interesting as it was a reverse-DCF calculation, determining what the assumptions must be to get the current share price. This for me rang a bell, the market was pricing in a very poor future scenario for Apple of no growth and higher risks. The downside risks had been considerably reduced and there seemed to be a margin of safety.

However, I still couldn't and didn't buy Apple shares......here is why, in no particular order.

1. I believed Apples future revenues would shrink because of competition.
2. I believed Apple would struggle to maintain its innovative competitive edge.
3. I felt uncomfortable in investing my own money.
4. The stock price had gone so high, I felt it had more to fall (although this turned out to be true!).
5. I was probably affected by the negative press.
6. I felt Apple's time as king of the hill was over.
7. Although it had low a valuation, e.g. P/E, I thought those earning were fragile and could easily erode away.
8. I don't like relying on someone else's analysis and conclusions for an investment.
9.The more it fell, the more I wanted to get it even cheaper yet wanted to somehow time the bottom tick.

Going back to the chart, the share price actually fell another 14% after reading that blog post, touching $54 twice before regaining ground and is now up 70% from those lows. Despite this big move Apple can still considered to be cheap based on earnings, free cash flow and shareholder yield.

Despite this, I still cannot pull the buy trigger (I blame anchoring bias!) and so continues my relationship with Apple.