Exact Sciences (NASDAQ: EXAS) investors are having a year to remember. Shares of the colon cancer detection company have been on an absolute tear in 2017, rising more than 187%. But after the stock has booked such a big gain in such a short period, can buy-and-hold investors still feel good about getting in on this exciting growth story now?
How we got here
Colon cancer claims more than 50,000 American lives each year, which makes it the country's second-deadliest type of cancer. That's doubly tragic because colon cancer is generally highly treatable if found in its earliest stages. Sadly, it's often not diagnosed until the later stages, where treatment options are limited.
Why is colon cancer not diagnosed sooner? The main reason is that patient adherence rates to current standard-of-care screening methods are abysmal. So low, in fact, that a study published in the American Journal of Managed Care found that only three out of every 1,000 patients follow the fecal occult blood test (FOBT) or the fecal immunochemical test (FIT) screening recommendations.
An innovative solution
Exact Sciences is on a mission to fix this problem. It developed an innovative, non-invasive screening tool that was easy for patients to use: Cologuard, a simple stool collection kit that is shipped directly to the patient's home. To use the test, a patient simply orders the kit, deposits a stool sample, and sends it back to Exact Sciences for analysis. The company analyzes the sample using its proprietary testing technology and then sends the results directly to the patient's doctor for follow up.
As you can imagine, the simplicity and privacy provided by Cologuard are highly attractive to patients. Furthermore, health care providers can feel good about recommending the test since a 10,000 patient clinical study showed that Cologuard correctly identified the presence of colon cancer 92% of the time.
The government was so excited about Cologuard's potential to save lives that the Centers for Medicare and Medicaid Services proposed a national coverage determination on the same day that Cologuard received FDA approval. That's the first time in history that has ever occurred. Understandably, enthusiasm for Exact Science's stock was riding high soon after regulators gave the Cologuard test the thumbs-up in August 2014.
Despite Cologuard's benefits and its clear potential to save lives, the product and company still had a fair number of detractors. Bears argued (correctly) that Cologuard was not as accurate as a colonoscopy at detecting cancer, and noted that it has a relatively high false-positive rate. That argument was reinforced in late 2015 when the U.S. Preventive Services Task Force suggested that Cologuard should be used as an "alternative screening test" for colon cancer instead of a "recommended" test. The news raised concerns that insurers would push back hard against covering it.
Furthermore, Exact Sciences' own data showed that about a third of the kits it shipped off to patients were never sent back to the company. That's not great news, since the company can't bill for its services until it gets the kit back and tests the sample.
These factors combined with the company's long history of losses and a huge short position to turn the 20-month period following Cologuard's launch into a brutal time for shareholders.
The Hail Mary
In an effort to turn its fortunes around, Exact Sciences decided to go on the offensive and spent big on a national advertising campaign. The company also focused more effort on reaching out to non-compliant patients to persuade them to send their tests back for analysis.
While this move was costly and bold, recent results clearly show the strategy is paying off. Last quarter, Exact Sciences announced that it completed 135,000 Cologuard tests, up 149% year over year. That impressive performance allowed management to up its testing guidance for the year to at least 550,000 -- a big jump from its prior outlook of 470,000.
The company has also made a lot of progress with getting insurers on board. Management recently announced contract wins with UnitedHealth Group and Aetna. With these contracts in place, the company now believes that 86% of its target patient population now has reimbursement access to the test.
Thankfully, this surging testing volume is translating into improving financial results, too. The company's top line jumped by 172% last quarter to $57.6 million. The increased sales leverage is also leading to margin gains and lower-than-expected losses. In turn, the shorts have been squeezed out of Exact Sciences' stock, which has help to propel the fantastic year-to-date results.
The surging stock price also enabled Exact Sciences to complete a secondary offering on favorable terms. Its cash balance now sits at more than $484 million, which should provide it with plenty of firepower to continue to invest in the business.
Is Exact Sciences a buy?
Even with an enormous surge in testing volume in the rear-view mirror, there are ample reasons to believe that the company's growth engine is just getting started. Management estimates that it has only reached about 2% of its current addressable market. The company also has plans to develop similar tests that will work on detecting pancreatic, esophageal, and lung cancers. Success in any of those other indications would meaningfully expand the company's addressable market opportunity.
However, offsetting that incredible growth potential are a few harsh realities. Exact Sciences is still setting fire to tens of millions of dollars each quarter and will likely continue to do so for the foreseeable future. It is also probably unrealistic to assume that the company will be able to meaningfully increase its compliance rates, which might keep a lid on future gross margin expansion. Finally, the drastic short squeeze has pushed up the company's valuation to more than 27 times sales. That ramps up the pressure on the company to continually exceed expectations. Any slip up could cause the company's stock to nosedive.
Despite those negatives, I happen to think that that the company's massive market opportunity and recent execution excellence justify a small investment today. However, those who agree with me and are willing to pay today's obscene valuation multiples to get in should mentally prepare themselves for a bumpy ride ahead.
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