- BA-ML initiates on Pharmaxis with Buy rating - Pharmaxis close to regulatory approval for Bronchitol - Low risk entry into potential market of more than $500m

By Chris Shaw

Since July of last year both Credit Suisse and RBS Australia have rated Australian pharmaceutical company Pharmaxis ((PXS)) as a Buy. BA Merrill Lynch has now added to the positive views on the stock, initiating coverage today with a Buy rating and a price target of $3.55.

The attraction for BA-ML is Pharmaxis is close to seeing research and development spending translate into commercialisation of lead product Bronchitol, used for treating cystic fibrosis. Regulatory approval for Bronchitol is expected in either March or July, which would allow for low-risk entry into a market estimated by BA-ML to be worth more than $500 million.

Bronchitol's market entry would give Pharmaxis two products on the market, the other being Aridol, used in the testing of asthma. Both products come in an inhalable form and utilise mannitol or small sucrose-like spheres for delivery.

Assuming Bronchitol can achieve 50% market share in the cystic fibrosis market at an assumed price of US$15,000 per patient per year, BA-ML estimates potential revenues of better than $410 million annually.

The stockbroker sees such a market share as possible given only around one-third of cystic fibrosis patients at present have a good response to the current main treatment option, Pulmozyme. As well, the broker point out Bronchitol would be used in conjunction with Pulmozyme rather than as a replacement treatment.

The news could potentially get better as BA-ML sees significant margin leverage for Pharmaxis as Bronchitol sales increase. This reflects the scalability of mannitol production and relatively low additional capex requirements.

Assuming sales increase as forecast through FY15, BA-ML estimates the ratio of fixed to variable costs could move from 65:35 in FY13 to 50:50 in FY15. This would lift gross margin from around 80% to as much as 90%. EBITDA (earnings before interest, tax, depreciation and amortisation) margins would also be expected to increase to better than 60% by FY16 from around 45% in FY14.

The Australian Pharmaceutical Benefits Advisory Committee meets this week to consider approval for Bronchitol, BA-ML expecting a favourable decision either this month or at the following meeting in July.

Subsequently there would be cabinet approval on a reimbursement level, BA-ML noting this would offer a price reference point. This reference point would be a key for sales expectations given a market of 75,000 potential users globally.

Based on its model, BA-ML has a discounted cash flow valuation on Pharmaxis of $7.10 per share. To take a conservative approach to reflect the risks associated with regulatory approval a 50% discount has been applied, as have conservative assumptions with respect to pricing and timing of market share expectations.

Long-term there remains further potential upside in Pharmaxis as BA-ML points out the company has a rich pipeline of products, including PXS25 and PXS4206 targeting lung disease and the potential for additional uses for Bronchitol.

BA-ML has set a price target on Pharmaxis of $3.55. This target is broadly in line with existing targets in the FNArena database, with Credit Suisse setting a target of $3.60 and RBS Australia $3.89. Both Credit Suisse and RBS were disappointed by recent delays in European regulatory approval for Bronchitol but both saw little valuation impact from the news.

While of less relevance at present given Pharmaxis is still in development phase for Bronchitol, consensus earnings per share (EPS) forecasts according to the FNArena database stand at minus 20.4c in FY11 and minus 12.3c in FY12. BA-ML is forecasting EPS of minus 20.5c and minus 17.1c respectively, before a move to positive EPS of 2.4c in FY13.

At present Pharmaxis has a net cash position of around $67 million, which BA-ML estimates is sufficient to last 1-2 years. This would see the company through to the expected commencement of profits in FY13.

Shares in Pharmaxis today are slightly weaker, trading 1c lower as at $10.30am at $2.37. Note: the share market as a whole is having another very bad day. Over the past year the stock has traded in a range of $1.65 to $3.41 and at current levels there is implied upside of better than 50% to the consensus price target in the FNArena database of $3.68.

FN Arena is building the future of financial news reporting at www.fnarena.com . Our daily news reports can be trialed at no cost and with no obligations. Simply sign up and get a feel for what we are trying to achieve.

Subscribers and trialists should read our terms and conditions, available on the website.

All material published by FN Arena is the copyright of the publisher, unless otherwise stated. Reproduction in whole or in part is not permitted without written permission of the publisher.