Ready for the Storm
As I sit down to write this issue, I can’t shake the feeling that we’re on the brink of something monumental. The closer we get to the US elections, the more palpable the tension becomes. It's like the entire world is holding its breath, waiting for the other shoe to drop.
Lately, it feels like we're on the verge of a significant upheaval. There’s an undeniable sense that we’re about to face a period of unprecedented turbulence. Think of Murphy’s Law—anything that can go wrong, will go wrong, and it seems poised to strike at the worst possible moment.
Globally, we continue to witness profound geopolitical shifts, mounting economic uncertainties, and a societal mood fraught with anxiety. As I’ve mentioned in previous issues, the most significant threat, in my view, is the sheer size of the global population combined with the unprecedented waves of migration to the developed world. With 8 billion people on the planet, the largest population in history, we are now facing the consequences of this massive demographic pressure. For example, here in Canada, a country once known for its peace and tranquility, we are now experiencing a surge in migration and crime. People are on edge, protests have become commonplace, and incidents of vandalism, car theft, murder, stabbings, and carjackings are on the rise.
In the United States, as the elections draw nearer, I expect the situation could deteriorate further. Bloomberg recently reported that residents in swing states are fearing potential violence during the elections. I share these concerns, as the political climate is already highly volatile. It wouldn't take much to trigger a major conflict. While it's difficult to predict the exact outcome, it's clear that we could be facing a turbulent second half of the year.
In the meantime, life continues, and the best strategy is to prepare for the worst while hoping for the best. For our portfolio, I am preparing with an assumption of a 65% chance of turbulence and a 35% chance of a more optimistic scenario. This month, I want to focus on the optimistic side by highlighting a sector with great potential and significant benefits for humanity: health care.
Striking Gold with the Right Tools
As a child, I was captivated by the story of the Klondike Gold Rush. I marveled at the adventurers who journeyed to unearth fortunes in gold. However, as I grew older, a different aspect of the tale began to intrigue me—the people who amassed wealth not by finding gold themselves, but by supplying the prospectors with picks and shovels. This strategy of enabling the seekers rather than seeking directly has fascinated me ever since, and I have become a staunch advocate of the "picks and shovels" business model.
Whenever I identify a trend brimming with potential, I search for a picks and shovels company that allows me to engage with that trend indirectly but profitably. This month, I'm excited to introduce a company that offers a unique entry point into a sector I've been keen to invest in: biotech.
I've always wanted to invest in biotech, but honestly, I don't know enough about the field to confidently choose the right names. The biotech sector is vast, with companies at various stages of development, making it a challenging area to invest in without spreading my bets and hoping for a few big wins. Fortunately, one of the newsletters I subscribe to highlighted a company that perfectly fits the "picks and shovels" model I prefer for my investments.
Certara (CERT:NASDAQ)
Certara is a contract research organization (CRO) specializing in providing biosimulation technology and Model-Informed Drug Development (MIDD) solutions for the global biopharmaceutical industry. Biosimulation technology, provides significant value to biotech and pharmaceutical companies by helping them manage their research and development (R&D) budgets more efficiently. The company's services allow for early virtual testing of clinical trials, enabling fine-tuning of dosages and avoidance of costly errors before drugs enter human trials. The company's goal is to help the life sciences sector make better decisions during drug development and commercialization, ultimately increasing productivity and reducing costs.
The drug development process is highly regulated and expensive, with the pharmaceutical industry spending over $260 billion annually on R&D. Certara's proprietary biosimulation platforms, built on biology, chemistry, and pharmacology principles, use advanced mathematical algorithms to model how medicines and diseases behave in the body. This technology has been validated over two decades, significantly decreasing costs and increasing the chances of new drug approval and commercial success. Certara specializes in making the complex regulatory process transparent and efficient, using its software and services to streamline the creation of regulatory filings and speed up data flow.
Certara generates revenue through the sales of software products and the delivery of consulting services. The software business includes revenues from software licenses, subscriptions, and maintenance. Software license fees are recognized upfront upon delivery, while subscription fees, providing access to cloud-based solutions, are recognized ratably over the subscription term, typically one to three years. Software maintenance revenue, which includes updates and technical support, is recognized over the contract term, usually one year. The services business, on the other hand, generates revenue from technology-driven and professional services, including software implementation, with revenues recognized based on the time services are performed or the progress towards completion for fixed fee and prepaid arrangements.
Certara's software and services platform allows clients to simulate various steps of clinical trials virtually. This biosimulation capability is crucial for:
Certara’s approach is particularly valuable given the high stakes of biotech R&D. Clinical trials are notoriously expensive and risky, with success rates for Phase II and Phase III trials hovering around 50-59% respectively. By providing tools that enhance the precision and efficiency of these trials, Certara significantly increases the chances of success for its clients.
Certara stands out by getting involved in clinical trial management much earlier than most CROs. Its biosimulation technology allows for virtual testing of clinical trials, enabling fine-tuning of dosages and identification of potential trial design errors before human trials begin. This early intervention helps clients avoid costly mistakes and increases the efficiency and success rates of their clinical trials, ultimately preserving valuable R&D dollars.
Financial Performance & Growth Prospects
Certara has established a strong market position, serving 39 of the top 40 biopharma companies and boasting over 2,300 customers worldwide. The company's biosimulation technology is highly regarded, making it an integral part of the clinical trial process for many leading firms. In 2023, Certara generated $354 million in revenue, with about one-third coming from software solutions and two-thirds from consulting services.
The company's growth prospects are promising. Certara estimates a total addressable market of $4 billion for biosimulation alone, having penetrated only 10% of this market so far. The overall market for Certara’s services is expected to grow at double-digit rates annually in the coming years. Additionally, Certara has demonstrated a strong track record of growth through strategic acquisitions, integrating 17 small companies over the past decade to bolster its capabilities and maintain high returns.
Certara’s focus on continuous growth and innovation positions it well to capitalize on the increasing reliance of biotech and pharmaceutical companies on CROs for efficient R&D management. With its leading position in biosimulation and a robust growth strategy, Certara presents a compelling investment opportunity in the biotech sector.
Financial Information
| Year | 2023 | 2022 | 2021 |
|---|---|---|---|
| Revenues (USD) | $354.3M | $335.6M | $286.1M |
| Gross Profit | $213.3M | $203.1M | $174.5M |
| Gross Margins | 60.2% | 60.5% | 60.9% |
| Net Income | -$55.4M | $14.7M | -$13.3M |
| Cash on hand | $235M | $237M | $186M |
| Debt | $288M | $290M | $292M |
| Free Cash Flows | $67.5M | $80M | $51.5M |
| FCF Margin | 19.05% | 23.84% | 18% |
| Shares Outstanding | 160.2M | 159.4M | 149.8M |
| Current Ratio | 2.62 | 3.32 | 2.98 |
On May 7th, Certara reported its financial results for the first quarter of 2024, showing notable growth in certain areas. The company achieved a revenue of $96.7 million, marking a 7% increase from $90.3 million in the first quarter of 2023. This growth was primarily driven by a 19% rise in software revenue, which reached $39.3 million, compared to $33.0 million in the same period last year. However, services revenue remained flat at $57.3 million. Despite these gains, Certara reported a net loss of $4.7 million, contrasting with a net income of $1.4 million in the first quarter of 2023, largely due to increased operating expenses aimed at supporting innovation and growth. Free cash flows for the period were $718k compared to $7.2M in Q1/2023.
The company reiterated its full-year 2024 financial guidance, anticipating total revenue between $385 million and $400 million and an adjusted EBITDA margin of 31-33%. Certara remains optimistic about its growth prospects, driven by strong customer interest and strategic investments in software capabilities. Despite some challenges this quarter, such as a decline in total bookings, Certara's commitment to expanding its software and services offerings positions it well for continued growth in the drug development industry.
Revenue by Geographic Area
I am highly optimistic about Certara and believe it represents a compelling long-term investment opportunity. Certara's unique position in the biosimulation market, its strong relationships with major biopharma companies, and its consistent revenue growth demonstrate its potential for sustained success. As a "picks and shovels" type of business, Certara allows me to participate in the biotech sector's growth without the direct risks associated with individual drug development. The company’s innovative approach to improving the efficiency and effectiveness of clinical trials significantly reduces R&D costs and enhances the likelihood of successful drug development. Given these strengths, I have initiated a position with a one-third tranche investment and plan to continue adding to my position over time. Certara's robust growth prospects and essential role in the biotech ecosystem make it a stock I am confident in holding for the long term.
Portfolio Update
As we enter the last month of the second quarter, the markets remain ebullient. However, I’m not entirely convinced that all is well. I see cracks forming that suggest a crash—or at least a significant pullback—may be imminent.
According to a recent Bloomberg article, the commercial real estate market is showing significant signs of stress, with investors in top-rated commercial mortgage-backed securities (CMBS) experiencing losses for the first time since the financial crisis. A notable example is the 1740 Broadway building in midtown Manhattan, where buyers of the AAA portion of a $308 million note backed by the mortgage on the building got back less than three-quarters of their original investment after the loan was sold at a steep discount. This situation underscores the deep distress in parts of the US commercial real estate market, particularly in older office buildings dominated by single tenants. Delinquency rates are climbing, with the share of delinquent office loans reaching 6.4% in April, the highest since June 2018. Some cities are facing even more severe stress, such as Chicago and Denver, where a significant portion of CMBS office loans are in trouble.
Also this week, the $10 billion Starwood Real Estate Income Trust (SREIT) took the drastic step of further tightening limits on shareholders’ ability to pull money, in an effort to preserve liquidity and stave off asset sales. The new restrictions, will cap monthly withdrawals at 0.33% of net asset value compared to the previous 2% limit.
The retail sector is also experiencing significant stress, not just the commercial real estate market. The list of restaurant closures in 2024 continues to expand, with Red Lobster recently announcing the closure of several locations. Other chains, such as Buffalo Wild Wings, IHOP, Denny's, and Applebee's, are also shutting down multiple outlets. Retailers are facing similar difficulties, with a rising number of store closures and bankruptcies. This trend is expected to lead to increased unemployment and potentially more unrest by the time of the US elections.
Given this outlook, I am steadfast in my cash preservation strategy, with over 90% of my portfolio currently held in cash, earning between 4.30% and 5%. My goal is to build a fortress portfolio in preparation for the impending storm. Additionally, I am looking to add an oil and gas play to hedge against potential spikes in oil prices due to geopolitical shocks. Meanwhile, I am very bullish on gold and continue to increase my holdings in Sandstorm Gold Royalties. Gold is traditionally seen as insurance against calamity, and with the US elections shaping up to be the most significant event of the decade, it is perhaps time to have a lot of gold and cash on hand. I have a strong feeling that we could see chaos erupting in the streets as we get closer to November. It's crucial to stay alert and be ready, both in our personal lives and in our portfolio strategy, for the storm that is approaching.
Below, you'll find a detailed table outlining the portfolio's composition as of the end of May 2024. Cash and GICs continue to make up the bulk of the portfolio, offering a solid foundation and ensuring that the portfolio remains robust amidst uncertainty.
Portfolio Composition
| As of March 2024 | |
|---|---|
| Category | Portfolio Weight |
| Cash and GICs | 92.62% |
| Speculative Picks | 1.85% |
| Defensive Picks | 4.40% |
| Crypto | 1.13% |
| TOTAL | 100% |
Remember that the content of this newsletter is neither a stock recommendation nor investment advice. This is just something to consider. You can access my watchlist and portfolio through the link below. By clicking the link below you accept all responsibility for any potential losses that might result from buying any of the stocks mentioned in this newsletter.