Cyanotech ( Nasdaq - CYAN ) -- Barrels Back

Cyanotech (CYAN $5.75) appears on track to report reasonably good Q2 (September) results.  The high potential astaxanthin line has continued to build momentum.  New growing ponds have entered production.  And average selling prices are drifting upward as output is diverted from bulk sales to higher margin packaged products.  The legacy spirulina line continued to encounter problems, though.  That segment still represents more than 50% of Cyanotech's growing capacity.  A variety of production issues have curtailed volume.  That's put a crimp in sales directly.  It also has incurred extra costs, as the company strives to fix the problem. 

Margins may be affected by the addition of two sales and marketing executives.  That's laying the groundwork for a pick-up in direct to consumer sales, via social media and other techniques.  It also is boosting distribution to a broader group of specialty retail stores.  Legal expenses will impact margins, as well.  Cyanotech is battling it out with a bulk customer that is trying to force the company to keep selling astaxanthin at abnormally low prices.  That issue probably won't be resolved for another two quarters, although there's little reason to think Cyanotech will be forced to continue the arrangement once the existing contract expires.

Meantime, worldwide astaxanthin demand still exceeds supply.  Industry growth has begun to moderate, following last year's surge.  But plenty of opportunity remains.  A large majority of specialty health food retailers don't carry astaxanthin products.  Large potential exists in the chain store segment, as well.

Our estimates are unchanged.  Near term performance is hard to predict due to the spirulina problem.  How fast Cyanotech can transition to higher margin retail products is another unknown.  The impact of legal and personnel expense is another question mark.  Still, a strong showing is likely due to the underlying strength in demand.  New competition has not emerged.  Astaxanthin and spirulina are complicated products to grow.  The long term outlook remains bright.  In 3-5 years sales could reach $50-$100 million to produce income on the order of $1.00-$2.00 a share.

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