Management at Chembio Diagnostics, Inc. (CEMI) has shown great resiliency in growing both the domestic and international sides of its business. Revenue grew at a CAGR (compound annual growth rate) of 33% from 2004 to 2009, and Chembio Diagnostics ended its most recent fiscal year with $309k in net income, marking 2009 as the first profitable year in company history.
Management has also done an excellent job in finding ways to take costs out of the business but at the same time reinvesting in newer technologies and higher growth opportunities. We view this as the beginning of the next significant phase of growth for the company as it begins to transition away from the lateral flow assays and into what we believe will quickly become the leading oral fluid rapid HIV test in the U.S.
Several Catalysts to Propel Future Growth…
Chembio is poised to deliver on several highly significant milestones over the next 18 months, which we expect to be the catalysts to tripling revenue over the next four years from the $13.8MM posted in 2009. Three of the four DPP products covered under the most recent FIOCRUZ technology transfer agreements, including the HIV 1/2 screening and HIV confirmatory tests, should receive regulatory approval and launch in Brazil by the end of the third quarter 2010. While this is a delay from initial expectations, the recent visibility significantly reduces further uncertainty and allows the Company to focus on U.S. commercialization of the DPP product portfolio.
Based on the compelling data from the various internal studies and field trials of the oral fluid DPP HIV 1/2 assay, we believe eventual FDA approval is likely. The data suggests the assay may have greater sensitivity and specificity than OraSure’s OraQuick ADVANCE HIV 1/2 oral fluid test as well as leading blood sample assays.
Clinical trials are underway and should wrap up towards the back half of the year. Our current expectations are for the DPP HIV 1/2 and DPP syphilis assays to gain FDA clearance and launch in 2011. We believe Chembio will have a huge opportunity to take significant market share from OraSure’s HIV oral fluid sampling product, which generates approximately $40 million in domestic revenue.
We expect the DPP assay to sell for about 25% less than OraSure’s product, and combined with other significant advantages of the DPP technology, we forecast sales to ramp very quickly upon FDA approval.
We also see significant opportunity for the DPP syphilis test. Based on the market size and significantly added convenience and clinical importance of a POC (point-of-care) test for syphilis, we believe Chembio’s DPP syphilis assay could easily have multi-million dollar potential.
The OTC market for the DPP HIV product is enormous and, due to the huge margins offered in this segment, is one which can be exponentially profitable for Chembio. We expect Chembio to seek OTC approval for this product following FDA approval to market it in the professional setting. In the meantime, Chembio may pursue OTC approval of its Sure Check assay, which is already FDA-approved and CLIA waived for the professional market. Sure Check’s easy-to-use barrel format would likely be ideal for the OTC market.
Finally, Chembio should also benefit from the macro-shift that is underway by healthcare providers shifting more testing from central labs to the POC setting. Higher healthcare costs, lower reimbursement rates, improved accuracy and the demand for and clinical advantages of immediate testing results will likely continue this trend indefinitely.
Near-term Expectations…
In the meantime and in the near-term, Chembio should receive approximately $900k in technology transfer fees from FIOCRUZ during the third quarter related to three of the four DPP products, which we believe will receive regulatory approval in Brazil. Chembio will begin shipping product related to these three assays, including the inventory (~ $420k sales value) that was carried through the first quarter.
We expect combined domestic and international sales of the lateral flow products to grow 11% in 2010. Chembio should also book approximately $1.5 million in revenue related to NIH Leptospirosis grant, and the Batelle/CDC and Bio-Rad development agreements.
R&D expenses will materially increase during the year as a result of clinical trials and regulatory activities associated with bringing the U.S. DPP products to market. We expect this to weigh on operating income and, despite the expected additional contribution from FIOCRUZ beginning in Q3, we forecast net income to come in slightly negative for the full-year 2010. While not imminent, we also believe Chembio may look for a modest amount of additional financing to act as a bridge leading up to the U.S. launch of the DPP HIV assay.
Longer-term, we project revenue to grow from $15.9 million in FY2010 to $18.7 million in 2011, benefiting from a moderate contribution from the mid-to-late 2011 U.S. launch of the DPP HIV and syphilis assays. We think this grows to $27.6 million in 2012 and $37.8 million in 2013. Our model does not currently incorporate a launch of the DPP products into the OTC market prior to 2013, although we expect an eventual OTC introduction to add significantly to the already robust long-term revenue and earnings growth prospects for the company.
We expect 2010 EPS to come in flat from 2009 ($0.00) but for Chembio to show continuous improvement for the foreseeable future, benefiting from significant growth in revenue and continuous improvement in operating margin. Based on our model we forecast EPS of $0.05 in 2013.
We are initiating coverage of Chembio Diagnostics with an Outperform rating. Based on the potential for the DPP product portfolio to significantly ramp long-term revenue, cash flow and earnings, we feel the company is grossly undervalued. Average valuation for competitors in the rapid diagnostic testing space is 2.2x estimated 2011 revenue.
Given that we estimate Chembio’s revenue growth rate will only begin to show significant acceleration beginning in late-2011 (following the DPP HIV and syphilis launch) and vastly outpace that of its competitors for the foreseeable future afterwards, we believe Chembio’s shares should trade at a significant premium. Our near-term price target of $0.90 is based on 3x our estimated 2011 revenue of $18.7 million.
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