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Crescita Therapeutics Analysis Part 2

For Part 1 of my Crescita analysis (CTX.TO, CRRTF) please read the previous post. I own shares of CTX.TO.

Crescita Therapeutics (CTX.TO, CRRTF) is a publicly-traded, Canadian commercial dermatology company with a portfolio of non-prescription skincare products and prescription drug products for the treatment and care of skin conditions and diseases and their symptoms. The company owns multiple proprietary drug delivery platforms that support the development of patented formulations that can facilitate the delivery of active drugs into or through the skin. The company owns a portfolio of non-prescription skincare products and has one FDA approved prescription product, Pliaglis that is licensed to Cantabria and Taro Pharmaceuticals for the U.S. market.

This will be Part 2 of my Crescita analysis. This post will thankfully be much shorter than Part 1. In this post, I will summarize my call with Executive Chairman Dan Chicoine. Second, I will discuss some of the research I have done locally on the Crescita skincare brands.

Crescita Analysis: Talk with Dan Chicoine

On October 25th, 2019, I spoke with Dan Chicoine and Linda Kisa (Financial Planning & Investor Relations). Linda was very helpful in scheduling a call with Mr. Chicoine. We spoke for about half an hour. Here is a summary of our conversation.

Question #1:

With $11.7 million dollars in cash, Crescita is at a pivotal point. What are the capital allocation priorities?

Crescita is looking to acquire a product or business that will immediately add EBITDA. This type of acquisition will preferably be in the medical skincare business and could be either prescription or non-prescription. Crescita’s operations are fully funded. A large portion of the $11.7 million is available for investment. Mr. Chicoine was very confident in CEO Verrault’s ability to find a suitable acquisition. CEO Verrault has years of experience in business development and is a great choice to be leading up the search for an acquisition.

Question #2:

The normal course issuer bid was approved on June 26th. What factors did you consider when initiating the normal course issuer bid?

Crescita management felt its shares were undervalued. Buying back shares was a better investment of their money than retiring their debt. It is an efficient way to raise future earnings per share and return capital to shareholders. I added to the question if the share buyback had anything to do with Knight Therapeutics selling off their shares. Mr. Chicoine explained that they had announced their share buyback program before Knight started selling their position. Their decision to buyback shares had nothing to do with Knight.

Question #3:

Your non-prescription skincare business is not profitable. What is your overall plan for the skincare segment? When do you anticipate profitability?

Mr. Chicoine acknowledged that their non-RX skincare line is not profitable. He thought that in one or two years they could reach profitability. Profitability would be achieved through a greater volume of sales. A greater volume would be obtained through organic growth and introducing new products.

I asked if he could expand on the non-prescription skincare industry in general. I expressed some of the concerns I had with the skincare industry and its competitiveness. Two of the four brands they acquired through the INTEGA purchase had to be discontinued. It would have cost too much money to properly launch the brands.

Mr. Choicoine agreed that the skincare industry is very competitive and that’s why they have focused on the medical skincare business as opposed to retail skincare. This is the reason they discontinued two of the brands they acquired from INTEGA.

The medical skincare industry, by comparison, is less focused on brands. With an ageing population, the medical skincare business is growing. Mr. Chicoine believes they can achieve higher margins through sales of medical skincare products compared to retail skincare.

Question #4:

Dermazulene was launched in China in Q2. What is the strategy for China and how big of an opportunity is it?

China is a very important opportunity for Crescita. Obviously because of the population in China but also because of the perception of Canadian made products. Mr. Chicoine said that Chinese consumers have a positive perception of Canadian made goods, more so than U.S. made goods.

Their launch in China is going well. Crescita entered China by partnering with an e-commerce platform. It took some time to build this relationship and they plan to continue to build upon it in 2020.

Crescita currently has one product in China. They hope to have three more additional products by the end of the year.

Question #5:

I asked how the company thinks about insider stock purchases and insider ownership? Mr. Chicoine had not purchased any stock since the rights offering in 2018.

Mr. Chicoine replied that he personally owns 5% of the company. At his age and net worth, he felt this was a comfortable level of ownership. Insiders own 12% of the company and no one is selling.

Linda Kisa added that they have a conservative approach to insider buying and have been on blackout for quite some time. They encourage their employees to act like owners and be owners of the company.

Question #6:

What is something that investors misunderstand about your business?

Mr. Chicoine offered a couple of points on things that investors misunderstand about Crescita. The first point was that although their revenue can be lumpy from quarter to quarter they are working on smoothing it out. Lumpiness in revenue is caused by their upfront out licencing revenue. Crescita is trying to smooth out its quarterly revenue by signing agreements like the one they did with Tetra Natural Health and Sundial Growers. The royalty revenue generated from these deals should smooth out their quarterly revenue making it more attractive to investors.

Further to revenue lumpiness, Mr. Chicoine felt like investors don’t assign much value to the diversification of their revenue streams. Crescita is generating revenue from three products line currently: Pliaglis royalty and out-licensing, non-prescription skincare sales, and contract development and manufacturing. Crescita will soon be generating a fourth stream of revenue from royalties on the use of MMPE and DuraPeel. This diversification mitigates company risk if one business line were to run into trouble.

The second point was that Mical 1 and 2 along with MMPE and DuraPeel are undervalued by investors. Crescita has very little investment to make into MiCal 1 and 2 however investors assign it little to no value. In relation to MMPE and DuraPeel Mr.Chicoine believes there is a lot of value to be unlocked that investors don’t understand.

Mr. Chicoine referenced the deal signed with Tetra as an example. The Sundial deal is another example and I’m sure one he would have mentioned if it had announced. Royalty revenue from their drug delivery technology will continue to grow over the next few years. Mr. Chicoine feels investors are not assigning any value to these technologies.

Question #7:

On the July conference call, CEO Verrault had the belief that there are no Pliaglis generics coming to market. Is there any update on Pliaglis and possible competition?

There are still no generics that will compete with Pliaglis. Mr. Choicoine also felt that the current competition for Pliaglis is not overly strong. There are other topical anesthetics but none with the strength and ease of use of Pliaglis.

Question #8:

Where do you see Crescita in 5 years?

Mr. Chicoine believes Crescita will continue to grow with strong sales and have a goal of $50 million in sales in five years.

My Thoughts On the Call

I haven’t spoken with too many management teams so I am still getting comfortable with the process. I felt prepared with what I believed were well thought out questions. Mr. Chicoine provided thoughtful answers with some insight from Ms. Kisa. My takeaways to add to my Crescita analysis from the call are:

Share buybacks

The decision to buy back shares was made after considering other capital allocation options. Crescita determined that share buybacks were an efficient way to raise earnings per share and more efficient use of capital then retiring their debt. The decision to buy back shares had nothing to do with Knight Therapeutics selling off their stake. I agree shares are undervalued. I like that they weighed various capital allocation options before choosing the share buyback program and it was made independently of Knight selling their shares.

Non-prescription skincare industry

Mr. Chicoine explained that Crescita will continue to focus on the medical skincare business as opposed to retail skincare. He believes there are better margins and less competition. A quick Google search shows that the skincare industry is growing at a healthy pace. Crescita will try and capture some of that growth through organic growth and acquisition.

China

China presents a very interesting opportunity. I was happy to hear that Crescita is expanding its products in China from one to four. Mr. Chicoine is pleased with the relationship they have built with their Chinese e-commerce partner and will continue to build upon it in the next year.

Drug Delivery Technologies

Mr. Chicoine felt that MMPE and DuraPeel were the things investors most misunderstood about Crescita. He believed that there are opportunities to gain royalty revenue from their technologies and we would see these revenues in the next couple of years. Speaking with fellow investors I agree with this point. I found it very hard to value MMPE as well as MiCal 1 & 2 because their level of success is hard to gauge. Most investors I feel view them as a bonus if they succeed while Mr. Chicoine was far more confident they would be meaningful to Crescita.

Local Crescita Analysis

LDR banner

In addition to the call with Mr. Chicoine, I conducted some very basic research on Laboratoire Dr. Renaud (LDR) around my local city London, Ontario. I visited the five institutions listed on the LDR website to try and gather some opinions on the LDR brand.

The results of my visits were mixed: One spa was closed, one was a very low end and dated hair salon with no product visible, one higher-end spa no longer carried the product and two higher-end spas still carried LDR.

I was able to speak with staff at the two high-end spas and the third high-end spa that no longer carried LDR. Their opinion of LDR was that it was a very good product. From all three locations they each mentioned that LDR has been around for over fifty years. The two spas and their consumers trust the brand because of its longevity.

One of the managers uses the product herself and in her words “loves” LDR products. The two spas have been selling LDR for many years and had no plans of removing them. The same manager also said that LDR is able to raise their prices a few percents per year and customers do not have an issue with the increased price. She felt the price increases were reasonable. Most of the LDR product she sells is to an older clientele who are not as price-sensitive as younger consumers.

Another interesting point made by one of the spa managers was her comfortability with LDR. She was trained using LDR products at esthetic school and this increased her familiarity with LDR.

Local Crescita Analysis Take-Aways

  • Laboratoire Dr. Renaud is a respected brand. Their longevity was mentioned by the two managers that are still selling the product;
  • LDR has displayed some pricing power. They have been able to raise prices two to three percent per year and consumers are still buying the product;
  • One manager uses the product herself and “loves” it;
  • Distribution in my city is lacking. Admittedly this is hard to gauge since the website is out of date but LDR is sold in a fraction of spas in London, Ontario;

Pro-Derm

The second part of my research was to buy some Pro-Derm products. First I emailed INETGA to ask some questions about products and received a helpful response. My wife ended up buying three products off Beautysense.ca. She ended up buying:

My wife has been using the products and notices a big difference between Pro-Derm products and retail products. She has noticed improved results specifically in the overall moisture of her skin. She was also pleased with the smell of the products. They were not overly scented. This preliminary research doesn’t add much value to my Crescita analysis but it makes me more familiar with their products at least.

Conclusion

Overall I was pleased with the conversation I had with Mr. Choicoine. I like the direction the company is heading. It is an asset-light business that is transitioning to recognizing more royalty revenue over lumpy one-time milestone payments. This will keep margins high and if they can continue to out-license their technology, greater profitability.

I am still skeptical about their non-prescription skincare business but Mr.Choicoine and Crescita have a clear plan to solely focus on medical skincare. The brief research I have done on the skincare industry shows it is growing at a decent rate. Their next acquisition will be extremely important and may shape the future of Crescita depending on its size. As a result, I’ll be watching the non-prescription skincare line closely.

I recognize the research I’ve done is very basic and adds only the smallest amount of value to my Crescita analysis but its a start. The next step in my Crescita analysis is to try and talk to some Doctors about their opinion on Pliaglis and its competitors. This may prove to be more difficult as getting access to Doctors will not be easy.


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