The Zacks Analyst Blog Highlights Quince Therapeutics and XBiotech
For Immediate Release
Chicago, IL – March 8, 2024 – Zacks.com announces the list of stocks featured in the Analyst Blog. Every day the Zacks Equity Research analysts discuss the latest news and events impacting stocks and the financial markets. Stocks recently featured in the blog include: Quince Therapeutics, Inc. QNCX and XBiotech Inc. XBIT.
Here are highlights from Thursday’s Analyst Blog:
Don't Know Much Biology? Tips for Picking Microcap Biotech, Pharma
My screen of microcap companies ($0-$1B market cap) yielded 2,103 names. Of these, 102 are classified as biotech with another 82 categorized as drug companies, totaling 8.7% of this universe.
Through my years in meeting with and studying these types of companies as a Microcap generalist, I’ve come to multiple conclusions about these industry subsets, beginning with the determination that they are inherently more difficult to assess.
Most of these companies are pre-revenue, so there is no evidence of market acceptance and less empirical financial data to comb through, so the extrapolation and prognostication process is by nature more tenuous. An analyst typically runs through a standard mental iterative process: is there demand for this product, what’s the market size, what’s the competitive moat like, what are the margins, etc.
But these companies are in the incubator stages of product development, hoping for the holy grail of FDA approval down the road which will result in commercialization. So, the normal analyst tests mostly don’t apply. This is not the proverbial widget factory.
As a lay person without any science degrees (my Econ degree doesn’t count --cue cough with muffled “soft science” comment), most of the time the science appears compelling or least a marked improvement over the status quo standard of care. But admittedly, the science is often quite dense and near impenetrable for this mind, although colorful pictures do seem to help.
Somewhat ironically, these microcaps are a “micro” world of genes, molecules, proteins and other miniscule biological mechanisms that keep me alive but I’ll probably never fully comprehend.
A common axiom in the investing world is to “invest in what you know”. Can an investor without a science background honestly adhere to this advice when investing in a biotech microcap? Are equity analysts with science backgrounds better biotech stock pickers? Here was ChatGPT’s response: There is limited empirical evidence directly comparing the stock-picking success of analysts with MDs or PhDs against those without in the biotech sector specifically. Successful stock picking in this sector likely requires a combination of scientific knowledge, financial acumen, and market insight.
I don’t believe, however, that all is lost for the generalist investor. I believe there are pragmatic ways to stratify risk, both on the science and investment side, which can augment the generalist’s stock picking in this area.
On one end of the science risk spectrum is complete avoidance. I’ve heard from some management teams that they don’t do cancer products because the genetic underpinnings of the pathology are simply too complex with too many unique characteristics based on the individual. In other words, “too personal.” This is obviously just one opinion and somewhat disconcerting to folks (myself included) who have lost loved ones to cancer. Regardless, it is a risk stratum to consider.
Consider also whether the drug has a metabolic interaction. A new topical ointment to treat skin infections is less risky from a side effects perspective than an ingested new drug into the bloodstream. Talk to any MD and it always seems to be about the liver. And one adverse outcome in a trial and the thing seems to get shut down pretty quickly. Why is there green hair growing on my back?
Another approach is to find stocks that focus more on the modality of drug delivery. In other words, the new modality, like a sublingual (under the tongue) tablet or nasal spray, is taking an existing and proven drug and delivering it via a new mechanism to promote better patient compliance, convenience, and accessibility. Or a slow-release mechanism that delivers a proven drug over an extended period of time and requires fewer injections and results in longer term efficacy. The focus in these cases is more about “incrementalism” than home-run type cures.
One can also try the “network” effect, meaning consulting with MD friends to gather opinions about these prospective new therapies. I have personally found this works better with existing medical products already in the market place, like ophthalmologist comments on certain eye drop products or cardiologists discussing specific heart catheter products. FYI-Ophthalmologists are known for having an astute business acumen.
Also be mindful of your objectivity. Avoid falling in love with a prospective treatment that targets a condition that afflicts a loved one. You can certainly root for the company and the progress of the new treatment but your passionate hopes and wishful optimism can distort your view of the financial and scientific realities. “Okay, I’ll give them one more quarter.”
One could also try to reverse engineer the process, a type of top-down process, beginning with the more pressing topical medical issues of the day like Alzheimer’s or the opioid addiction crisis. Sometimes I’ve found myself trying to get inside the mind of the FDA. Given the lack of advancement on these aforementioned issues it would seem that any new treatment promising marginal improvement would get “fast track” designation. But I confess this strategy hasn’t particularly worked for me. Perhaps the lesson is don’t try to understand government thinking and their risk assessment protocols.
On the investment side of risk stratification, I asked a biotech CEO how she would go about picking microcap biotech stocks. This CEO was a MD with an MBA. She indicated that she’d look hard at the management team. Do they have a history of getting multiple drugs approved? Getting products across the FDA approval finish line are like career coaching wins. In her mind a winning record matters.
She would also prefer a CEO with an MD background or hard science background in addition to business experience to rule out the risk of “promotional” type CEO’s. And of course, she’d want a wad of cash with a long runway for product development. She’d then buy a small basket of companies meeting these criteria and hope one of them hits.
On this note, it is important to evaluate quarterly cash burn and expense levels. Do these levels just seem high, imprudent, and unmindful of shareholder interests? Cash efficiency is arguably the most important metric.
And a bevy of milestone events over the next 12 months like clinical trial data, academic papers, presentations, etc. is preferable. Hopefully these events contain positive new data which could move the stock given there is no sales activity to mention.
The cash runway should also be long, typically at least 12 months to allow these milestone events to unfold and to avoid the dreaded spiral of perpetual dilutive equity raises. While recently better, the fundraising environment for the biotech space can be especially brutal and can dry up quickly and often moves in concert with interest rate movements. Some revenue, like in the form of another product, albeit small, or government grants can also be helpful.
Quince Therapeutics, Inc. fits this bill of incrementalism (doesn’t imply lack of innovation) and checks a lot of the boxes on the financial risk side. The company acquired a Phase 3 asset last October called EryDex, a drug encapsulation process and blood cleansing methodology that “encapsulates” the steroid dexamethasone within red blood cells to allow a slow release.
As we know steroids can be highly effective treatments but the number of doses is limited due to toxicity concerns so the efficacy often wanes. The encapsulation process allows for a monthly administration for two hours which spreads out the steroid release allowing for a longer duration of effective treatment of symptoms.
The initial target of EryDex is Ataxia-telangiectasia (A-T), also known as Louis-Bar Syndrome, a rare neurodegenerative disease. The company estimates this to be a $1B market opportunity with no current approved treatments. The Phase 3 trial is expected to begin in Q2 with topline results expected in 2025. The company has $83.2 m of cash and cash equivalents which it expects will be sufficient funding into 2026 assuming positive Phase 3 results. The somewhat limited nearer term milestones is the main risk factor meaning this could be a bit of a waiting game.
Another microcap biotech stock that meets most of these criteria is XBiotech Inc.. Due to a 2019 divestiture to Janssen Biotech, a division of J&J, the company has cash and cash equivalents of $202 m which they expect to provide at least 12 months of spending runway.
The company is investing heavily in production capacity. The company collects donor blood samples, segregates out the most ideal antibodies, and then clones the genes responsible for the most robust antibody responses. These are the antibodies that block interleukin-1, the cytokines that regulate inflammatory responses. The divestiture to Janssen was also an interleukin-1 blocker but for dermatological indications.
The company’s lead asset is a Rheumatoid arthritis antibody in Phase 2. The company also has a stroke therapy drug candidate in Phase 1, Hutrukin, designed to lessen the inflammatory response seen after reopening arteries pursuant to a stroke. We believe the company’s success at commercializing the natural human immune response is noteworthy and could lead to other successful divestitures for other indications. At a minimum there is a record of successful asset development. The main risk factor is time given there are no Phase 3 assets at this point.
While biotech’s have rallied of late, they still remain measurably lower than 2021 as the chart below depicts. My conversations with management teams suggest the previously dried up funding environment is slowly improving. Companies have been forced to rationalize more in order to get the financing spigots flowing again.
While it could be argued that the easiest path is simply to take a small allocation in a biotech ETF i.e. make a sector bet, I realize there is a segment of the reading audience that enjoys the “thrill of the hunt,” like me, in evaluating individual companies. In this case, my hope is that these tips can at least provide a neon orange jacket for the hunt.
For more details about investing in microcap stocks, check out our Microcap Investing Primer.
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