When we wrote our “Investment Comments” back in April of last year, the S&P 500 was nearing new all-time highs due in part to what we deemed a “weak dollar rally.” The U.S. dollar was falling against the euro at the time, providing a tailwind for the U.S. economy, especially its big multinational corporations. Fast forward a year and currency movements are once again at the forefront of the market’s attention. However, the current environment is a complete reversal of what we saw last April, as the U.S. dollar has surged against not only the euro, but the vast majority of foreign currencies. In fact, April to early May of last year proved to be the exact top of the euro’s rally against the dollar. It has been all downhill from there, as the euro has fallen roughly 25% versus the U.S. dollar since that time. This has converted last April’s currency tailwind into a significant headwind that has led to much more volatile markets.
We also noted that the global economic picture was growing cloudier in our comments last April. Specifically, China was showing serious signs of slowing down as exports were decreasing at rapid levels. Based on the weakening economic data, the People’s Bank of China began a monetary easing policy to devalue its currency. Since last April, the People’s Bank of China has continued to cut interest rates, and a plethora of countries have followed suit. In fact, 24 different central banks have increased their monetary easing programs in this year alone. This has led to the unprecedented surge in the U.S. dollar against almost all major currencies. At the same time, political turmoil in emerging markets like Russia and Brazil has led to rapid devaluations of their currencies, spreading worries of global currency contagion.
In last April’s comments, we stated “the most pertinent question for U.S. investors is whether recent economic data is likely to alter the course of the Federal Reserve’s tapering policy.” We were right to believe it would not, as the Fed ended its quantitative easing program on schedule in October of last year. Similarly, the most pertinent question for investors now is whether slow global growth and currency contagion worries will delay the Fed from finally raising interest rates on schedule in the second half of this year.
Under the prospect of higher interest rates, it is important to be increasingly mindful of the P/E multiple paid for new investments. With this in mind, last April we discussed the merits of a long-term investment in the stock of a leading genetics testing company, Myriad Genetics (NASDAQ: MYGN):
Fiscal second quarter sales increased 37% and EPS was up 58% to $0.66. Pairing this growth with a trailing P/E of only 15 makes the stock look inexpensive. However, while we like the firm’s prospects for long-term success, we think investors need to know the short-term uncertainties which come with a purchase of these shares.
The short-term uncertainty was certainly an issue as the shares currently sit at the $35 level, precisely where they were when we suggested them a year ago. The stock has taken a wild and bumpy ride to arrive back at its $35 starting point. The shares initially popped above $40 after our commentary in early April, on news that the Medicare reimbursement rate for Myriad’s BRACAnalysis test would be cut significantly less than expected. However, the shares dropped back to the low $30s a month later when Myriad reported fiscal third quarter 2014 results, even though the results beat top and bottom-line consensus estimates and management raised FY2014 guidance. This is the bizarre short-term price behavior that Myriad shareholders have grown accustomed to partly as a result of the stock’s consistently high short interest.
Shares soon climbed back to the high $30s on the back of positive clinical study results for the company’s myPath Melanoma test and its newest breast cancer test, BRACAnalysis CDx. The stock then traded sideways until disappointing fiscal first quarter 2015 results sent it tumbling over 10% once again. The poor revenues and profitability for the quarter resulted from exceptionally high demand from physicians for Myriad’s myRisk Hereditary Cancer panel test, which caused laboratory capacity constraints. This issue was short-term in nature and investors soon looked past it, bidding the stock back up to the high $30s on the view that exceptionally fast-growing revenues from the myRisk cancer panel test would make up for competitive pressures on Myriad’s core single cancer tests.
In keeping with the recent trend, the shares went right back into correction mode when second fiscal quarter 2015 results were announced on February 3rd. The stock dropped almost 10% again after results beat Wall Street’s lowered estimates, but the company guided FY15 revenue and EPS downward. The new guidance calls for FY2015 revenue of $730M-$740M and EPS of $1.50-$1.55, significantly below the prior consensus estimates of $796.1M and $1.85, respectively. Management stated the lowered guidance was due primarily to delays in obtaining reimbursement coverage for its rheumatoid arthritis and prostate cancer tests. Also contributing to the stock’s selloff from the $38 level to the $34 level was the announcement by the company that the CEO for the last 24 years, Peter Meldrum, was retiring at the end of the 2015 fiscal year in June, to be succeeded by Myriad Genetic Laboratories president Mark Capone.
Since the selloff in early February, the shares have climbed back north of the $35 level as the company announced an increase in its share buyback program, and investors refocused on long-term growth trends. The stock of Myriad Genetics is very difficult to short-term trade due to its extremely high short interest levels (currently 45% of float) and volatile price action. The short thesis contends that Affordable Care Act reimbursement cuts for Myriad’s tests and key losses in patent protection will lead to increased competition and deteriorating revenues. However, we believe the company’s expertise in the field will allow Myriad to continue to introduce new best of breed tests to overcome these challenges in the long run. The combination of high long-term growth trends, ample margins, and zero debt continue to make the stock appealing for long-term investors.