The bad news was free flowing at a Sirtex Medical investor briefing yesterday. A deeper analysis of three clinical trials (known as SIRFLOX, FOXFIRE and FOXFIRE Global) that compared the company’s SIR-Spheres radiotherapy with conventional chemotherapy failed to find an improvement in overall survival among patients with liver cancer.
Another study, known as SIRveNIB, which compared SIR-Spheres to a drug therapy called sorafenib, was also unable to show that administering SIR-Spheres increased the length of time the patient stays alive following treatment. Safety and toxicity measurements, however, favoured SIR-Spheres. This was a similar result to that of the recent SARAH study (see Sirtex gets a scalding from SARAH).
Market likely to remain small
Salvage market unchanged
Share price reflects lower growth
Further analysis of the trial data, which is ongoing, could reveal some hidden benefits of SIR-Spheres to specific patients. Preliminary analysis, for example, showed a 4.9 month improvement in life expectancy for patients with right-sided primary colon cancer, though these sub-populations are small and are unlikely to move the needle much for Sirtex.
The bottom line is that all the studies were a flop and that pretty much eliminates the possibility of SIR-Spehres becoming a first-line cancer treatment. It’s likely to remain a therapy of last resort.
Salvage market still intact
As acting chief executive Nigel Lange put it: ‘Commercially, management expect the overall study data to have minimal impact on our current business as the vast majority of metastatic colorectal cancer (mCRC) patients currently treated with SIR-Spheres have failed all of the standard chemotherapy treatments. In our existing markets, the salvage metastatic colorectal cancer market represents an annual market opportunity of 42,000 patients. Within the salvage setting, there is extensive scientific evidence of the benefit of SIR-Spheres and selective internal radiation therapy is recommended in mCRC treatment guidelines across the globe’.
In other words, the failed studies mean it will be an uphill battle to grow sales, but there is still a decently sized market for SIR-Spheres as a last resort treatment. Sirtex already commands a sizeable share of the salvage market, with around 12,000 doses sold in 2016. There’s still plenty of evidence that treatment with SIR-Spheres is better than doing nothing at all; what these recent studies suggest is that SIR-Spheres isn’t better than competing therapies used earlier in the ‘treatment ladder’.
Unfortunately, that does increase the long-term risk that SIR-Spheres will one day be made obsolete by new cancer therapies showing up higher in the ladder that are more effective than SIR-Spheres. As a last resort therapy, SIR-Spheres are reserved for a very small pool of patients, and that means small improvements to survival rates higher in the ladder can have a big impact on the number of patients reaching the bottom of the ladder (see Sirtex: The bull and bear case). So what should investors do?
Buy, hold or sell
Earlier in my career I worked as part of a professional gambling syndicate. It taught me to think of the world in terms of probabilities, where success wasn’t in picking winners, but rather in finding mispriced bets – ones where the odds and potential payoffs more than compensate for the risks.
This way of quantifying uncertainty is also a key tenet of investing. For you to estimate the intrinsic value of a company using probabilities you need to judge a variety of outcomes and what you’ll earn under each scenario. The problem is that not only must we estimate what the outcomes will be, but also the probability that should be assigned to each case.
Humans are known to be very poor at forecasting the future – we tend to simply extrapolate our recent experiences. For this reason, intelligent investors will only buy a stock at a large discount to its ‘intrinsic value’. Intrinsic value, however, is not a precise figure to several decimal points; a company has different values depending on your assumptions. The price you pay relative to those potential outcomes is what determines whether you are gambling or investing.
Where we stand
That brings us back to Sirtex. Over the past four years, its share price has swung as low as $10 and as high as $41 – yet we’ve consistently maintained a Hold recommendation. But surely, you may be thinking, if Sirtex was a Hold at, say, $20, it would have been a Sell when the stock was double that, and a Buy now that it’s trading at half?
At its core, a valuation of Sirtex hinges on two variables: the probability that SIR-Spheres becomes a frontline cancer treatment or remains as a last resort, and the future cash flow that could be generated by the company under each condition.
Over the past four years, Sirtex has released a series of clinical trial results – some favourable, some unfavourable – that changed our estimate of the probability that SIR-Spheres could become a frontline treatment and therefore access a potential market that’s a good 10 times larger than the current one. The trouble is that as the probabilities and valuation changed, the share price tended to move with them. The share price has never been far enough away from our estimate of intrinsic value to say the stock is clearly mispriced – in either direction.
Unfortunately, we’re still in the same boat. With the latest clinical trial results in hand, the prospect that Sirtex will be able to access the front-line market now seems remote, and that takes a sizeable chunk out of our prior valuation. The share price, however, has declined by a similar amount and so, rather boringly, the stock still seems to be trading around its fair value.
Management expects earnings before interest, tax, depreciation and amortisation (EBITDA) of $65–74m in 2017, putting the company on a price-earnings ratio of 13 based on consensus estimates for 2017 earnings. Revenue is unlikely to grow at anywhere near the rate of the past decade, and it’s now reasonable to assume Sirtex is operating in a low-growth mature market.
We don’t expect earnings growth much above the low single digits, if it occurs at all, so a lower price-earnings ratio is justified. Nonetheless, with $99m of net cash, a free cash flow yield of around 6.9%, and a stable competitive position, we continue to recommend that you HOLD.