Investment Thesis

With the FDA approval for Guardant360, Guardant Health, Inc. (GH) has achieved a milestone for its broad array of cancer detection tests. Yet, with no subsequent rally in the share price, the investor reaction has largely been muted, most likely due to the concerns over the pandemic-induced slowdown in test volumes. The lukewarm growth forecasts seen in consensus revenue and the discount in trading multiple compared to the historical average underscore the concerns.

Yet, the vaccine hopes could reverse the pandemic-related slowdown. Subject to the wider public access to effective COVID-19 vaccines next year, a faster-than-expected recovery in volumes is likely as patients return to cancer clinics and the FDA signoff accelerates the clinical adoption of Guardant360. Assuming the historical average of trading multiple, our more sanguine revenue forecast for the next 12-months indicates an attractive premium offsetting the near-term concerns over growth. Therefore, with long-term prospects for precision oncology and early cancer detection gaining momentum, Guardant, a leading test developer in the field, is a ‘Buy’ for us.

Guardant Health_Company Pic_2

Source: The Company Website

A Regulatory Win At Long Last

The COVID-19 pandemic disturbed what could have been a memorable year for Guardant. Since its IPO in 2018, the company scored its most significant clinical milestone. In August, the FDA greenlighted its liquid biopsy test, Guardant360 CDx, for tumor mutation profiling of solid tumors and as a companion diagnostic to identify non-small cell lung cancer (NSCLC) patients suitable for Tagrisso® (osimertinib). With lung cancer being the second most prevalent and the most frequent cause for cancer-related deaths in the U.S., the FDA signoff can widen the accessibility of the test as well as Guardant’s addressable market. Yet, amid pandemic-related concerns over its revenue growth, the first-ever regulatory win hasn’t sparked the share price rally that usually follows such announcements.

The regulatory signoff should raise hopes for Guardant’s broad portfolio of cancer tests, which aim to detect all stages of the disease through liquid biopsy. Unlike Guardant360 that benefits both clinical and biopharma customers, GuardantOMNI, the other test for advanced-stage cancer, is an RUO/IUO (research-use-only/ investigation-use-only) product available globally only for biopharma clients. Both tests feed the development of the company’s LUNAR program. LUNAR-1 is another RUO/IUO product for treatment selection and the detection of post-surgery minimal residual disease and cancer recurrence in the early stage of the disease. The most promising test, under development seeking FDA approval and CMS coverage, the LUNAR-2 assay targets early cancer detection in asymptomatic and high-risk individuals.

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Explosive Growth Comes to a Halt

On an LTM (last twelve-month) basis, the company’s top-line had more than doubled compared to the year-ago period for four consecutive quarters through Q1 2020 (first quarter of 2020). Then the pandemic spread across the U.S., where Guardant sources ~90.6% of its revenue. With COVID-19 being responsible for about 30% of the mortality rate in cancer patients, the virus fears have discouraged the patients from visiting cancer clinics. The burst in test volume growth seen in 2019 has come to a grinding halt. However, as the coronavirus cases showed signs of easing in August following the surge in early summer, a slight recovery has begun in Q3 2020. After back-to-back declines sequentially, the total test volumes in Q3 2020 have jumped ~21.3% from the previous quarter. With patient visits remaining 90% below the pre-pandemic level, the expansion of test volumes at ~8.0% YoY in Q3 2020 stands far below the ~76.6% YoY growth in 2019.

Near-term Consensus Needs a Revision

Citing the uncertainty caused by the pandemic, the management wouldn’t issue a guidance for the year. But with COVID-19 making a resurgence in the U.S., the clinical test volumes, generating ~47.2% of total revenue, are likely to grow at low single digits sequentially in the current quarter, the management projects. The test volumes from biopharma customers, generating ~37.1% of the top-line, will expand at a similar rate to the past quarter. The consensus estimate for 2020 reflects the gloomy outlook. Indicating ~32.9% YoY growth, ~$284.9 million of consensus revenue forecast for 2020 implies ~21.6% YoY growth for Q4 2020. The deceleration compared to ~22.5% YoY growth in Q3 2020 mirrors the management comments. However, the Street forecast for NTM (next twelve-month) revenue at ~$346.5 million implies ~27.7% YoY growth. From ~47.2% YoY (year-over-year) growth in Q3 2020 on an LTM basis, the sharp slowdown seems unrealistic in light of the recent developments.

Guardant Health_Revenue Growth Source: Koyfin

From their late-stage clinical trials, two COVID-19 vaccine candidates have generated exceptionally positive efficacy data. Pending the FDA approval, the frontline workers and the vulnerable groups are likely to receive the first shots before the wider availability expected in mid-2021. A subsequent respite in the virus spread will likely accelerate the recovery in test volumes as patients eventually return to doctors’ offices to seek cancer care, something they cannot postpone indefinitely. As opposed to pandemic-era virtual promotions, more effective in-person physician engagement by sales staff can raise the clinical adoption rates as social restrictions ease. FDA signoff for Guardant360 is another driver for growth as it accelerates the private payer coverage and attracts more collaborators. Janssen Biotech has already teamed up with Guardant to develop and commercialize Guardant360 as a companion diagnostic for its experimental NSCLC therapy, amivantamab. Assuming a faster pickup in test volumes than suggested by the consensus, we project ~42.1 – 47.2% YoY growth in LTM revenue for the company, leading to ~$385.5 – ~$399.3 million in revenue.

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Guardant Health_Operating Loss Source: Koyfin

Improving Liquidity Despite Widening Operating Loss

Guardant recorded the highest ever quarterly gross margins in Q3 2020. But margin expansion hasn’t offset the impact from shrinking revenue growth, and for the second quarter in a row, the operating loss has widened by multiple times from a year ago. The ongoing clinical trials will only accelerate the rising cash burn. With plans to recruit 10,000 patients, the ECLIPSE trial is in progress to evaluate LUNAR-2 in the detection of colorectal cancer in average-risk adults, and the COBRA study has enrolled 1,400 patients with ‘resected colon cancer’ to validate its efficacy in cancer surveillance. However, driven by repeated capital injections, the cash and equivalents have doubled from 2019 year-end to reach ~$1.0 billion in Q3 2020.

Guardant Health_YTD Share Price Source: Koyfin

Guardant Health_Valuation MultiplesSource: Koyfin

Undervalued Despite Regulatory Win

Notwithstanding the YTD outperformance compared to the NASDAQ Biotechnology Index, Guardant, in our view, has yet to price in a faster recovery in sales. With EV at 28.5x of 12-month forward sales, the company trades at a ~24.8% discount to its 2019 average of ~37.9x. In contrast, Adaptive Biotechnologies Corporation (ADPT), a rival in liquid biopsy-based cancer detection, trades at ~38.8x in terms of NTM EV/Sales with only a ~9.6% discount to its 2019 average. Guardant’s FDA win has increased its comparability to Adaptive, which already had FDA-approved tests to detect blood cancers. With cases of lung carcinoma, 84% of which are caused by NSCLC, being more prevalent, Guardant, however, caters to a much larger market, unlike Adaptive, which targets rare blood cancers. Assuming ~37.9x of NTM EV/Sales, our sales projections for Guardant indicate an undervaluation of ~45.0 – 49.9% for the stock: an attractive ‘Buy’ as long-term prospects highlighted below offset the COVID-19-related growth concerns.

Guardant Health_ValuationSources: The Author; Data from Seeking Alpha and the Author Estimates

COVID-19 Threat Offsetted by Long-term Prospects

The COVID-19 case counts are rising in record numbers in the U.S., and according to health experts, the worst has yet to come as winter approaches. Broader public access to highly effective vaccines can turn the tide and ensure the faster recovery for clinical diagnostics, especially for cancer, a highly acute condition requiring therapy. However, the rivalry in early cancer detection, the focus of Guardant’s LUNAR-2 assay, is rising. In September, Illumina, Inc. (ILMN) paid $7.1 billion in cash and stock to acquire GRAIL, Inc. (GRAL), a developer of liquid biopsy-based tests for early detection. Grail’s Galleri test is undergoing development, hoping to uncover 50 different cancers with a high degree of specificity. Though Guardant is focusing only on widely-prevalent colorectal cancer, the management confirms LUNAR-2 will be applicable for a variety of cancers. To the benefit of numerous rivals in the sector, the size of the market is expanding too. According to Illumina, early detection could make up ~61% of the global market for cancer genetic sequencing, which is growing at 27% of CAGR (compound annual growth rate) to reach $75 billion by 2035. Meanwhile, thanks to advances in genomics, precision-driven cancer treatments are gaining momentum. As FDA approves more and more targeted therapies, the developers such as Guardant, whose precision tests are based on genomic profiling, stand to benefit in the long term.

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Conclusion

The recent FDA signoff for Guardant360 hasn’t fueled the expected share price rally in Guardant. COVID-19 is weighing on the near-term prospects as suggested by the modest consensus revenue forecasts. The NTM EV/Sales is also trading at a discount compared to historicals. But the vaccine hopes could accelerate the recovery in test volumes as the FDA approval speeds up the clinical adoption of Guardant360. With our more upbeat sales forecasts, the 2019 average in NTM EV/Sales indicates a sharp premium. As the company’s long-term prospects in early cancer detection and the precision-oncology outweigh the near-term risks from COVID-19, Guardant is a compelling ‘Buy’ for us.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



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