If you are looking for the best ideas for your portfolio you may want to consider some of Laughing Water Capital's top stock picks. Laughing Water Capital, an investment management firm, is bullish on Avid Bioservices Inc. (NASDAQ:CDMO) stock. In its Q2 2019 investor letter – you can download a copy here – the firm discussed its investment thesis on Avid Bioservices Inc. (NASDAQ:CDMO) stock. Avid Bioservices Inc. (NASDAQ:CDMO) is a biotechnology company.
In July 2019, Laughing Water Capital had released its Q2 2019 investor letter. The investment firm said that Avid Bioservices Inc. (NASDAQ:CDMO) was one of the top five positions in Q2 2019. Avid Bioservices Inc. (NASDAQ:CDMO) stock has posted a return of 37.0% in the trailing one year period, outperforming fund's benchmark the S&P 500 Index which returned 13.3% in the same period. This suggests that the investment firm was right in its decision. On a year-to-date basis, Avid Bioservices Inc. (NASDAQ:CDMO) stock has fallen by 3.5%.
Laughing Water Capital fund posted a return of 10.3% in the second quarter of 2019, outperforming fund's benchmark the S&P 500 Index which returned 4.30% in the same period. Let’s take a look at comments made by Laughing Water Capital about Avid Bioservices Inc. (NASDAQ:CDMO) stock in the Q2 2019 investor letter.
"Avid Bioservices (CDMO) – Avid was first introduced to the partnership in the 1H’18 letter as a small position, and then appreciated into a mid-sized position. The company is a Contract Drug Manufacturing Organization focused on biologics. In early May the company’s CEO resigned unexpectedly, causing shares to fall more than 20%.
Drilling down past the GAAP numbers reveals that CDMO is essentially a “good co/bad co” situation where the results of a second facility that was built on spec has been a major drag on consolidated results. By way of illustration, looking back at FY16 results and isolating the performance of their first facility reveals that this business formerly ran at ~50% gross margins. However, over the last few quarters as the company has been building out their second facility, consolidated gross margins went negative, and the company had been burning cash.
Following the sell off, shares traded hands at a level where I believed we were paying a fair price for the first facility, and getting the second facility for free. Importantly, management had indicated increasing sales momentum with existing customers as well as new customers, and a board member was perfectly suited to step in as interim CEO. I thus added to our position substantially on the weakness.
Fourth quarter earnings (fiscal year end 4/30) showed CDMO gross margins returning to 20% and positive cash flow as occupancy has risen to a level where operating leverage on the gross margin line has kicked in. This led to the company issuing positive forward guidance, and shares rerated significantly. This is a recession proof business that importantly lies outside the crosshairs of politicians who are eager to attack health care companies and drug companies more specifically. The actual manufacturing cost of pharmaceuticals is a very small piece of the total cost of a drug and regulatory compliance is of vital importance, so even if drug prices come under pressure, the manufacturers are unlikely to be asked to carry any freight. While there are sure to be bumps in the road going forward as customer volume requirements ebb and flow, demand for small batch biologic manufacturing is strong and growing, and it appears as if CDMO has successfully navigated the buildout of their second facility, meaning that this investment is now “good co/good co.”
From this time forward operating leverage should be significant as new sales are realized. Importantly, the company has levers to pull with their capital structure that can increase per share value, and the runway for future growth remains long as CDMO has the potential to once again double existing capacity in the coming years. Notably, this future capacity is likely to ultimately be brought online in conjunction with customer financing, which will be much less painful than the recent speculative capacity expansion. It should be noted that this sort of arrangement is typical for the industry, which is important in context of the risk of industry supply outstripping demand. Quite simply, at the moment demand is exceeding existing supply, and absent speculative building the worst-case scenario should be equilibrium.
Any sort of long-range projections are guaranteed to be wrong and should not be taken too seriously, but it is not unreasonable to think that within 4-5 years CDMO could be well on their way to tripling existing revenue guidance. This would be near the end of their existing growth runway and would thus unlikely deserve a multiple inline with recent industry transactions, but even absent additional growth, recession proof recurring revenue and its associated cash flows deserve high multiples, meaning that in my view CDMO still has multi-bagger potential in the years to come."
Last month, we published an article revealing Laughing Water Capital's bullish investment thesis on Avid Bioservices Inc. (NASDAQ:CDMO) stock in its Q2 2020 investor letter. This suggests that the investment firm has been bullish for a long time on Avid Bioservices Inc. (NASDAQ:CDMO).
In Q1 2020, the number of bullish hedge fund positions on Avid Bioservices Inc. (NASDAQ:CDMO) stock decreased by about 35% from the previous quarter (see the chart here), so a number of other hedge fund managers don't seem to agree with CDMO's growth potential. Our calculations showed that Avid Bioservices Inc. (NASDAQ:CDMO) isn't ranked among the 30 most popular stocks among hedge funds.
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Video: Top 5 Stocks Among Hedge Funds
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Disclosure: None. This article is originally published at Insider Monkey.