Wednesday, December 12, 2012

Cyanotech ( Nasdaq - CYAN ) -- Restores Growth

Cyanotech (CYAN $5.00) appears on track to produce excellent on target Q3 (December) results.  The company experienced production problems with its Spirulina line during the past two quarters.  That issue has been resolved, enabling output to rebound to previous levels.  Astaxanthin volume wasn't impacted.  That line probably will diminish as it usually does during the winter, due to reduced sunlight.  But on a year to year basis production remains at a high level.  Cyanotech added several marketing executives earlier in the year to build the retail and Internet channels.  Those efforts are beginning to bear fruit.  Greater traction is likely in subsequent periods.  Average prices are rising as more output is shifted from bulk to retail customers.  Orders continue to outpace capacity by a sizable margin.  Income is poised to show a solid positive comparison in the December quarter.  Cyanotech currently outsources its "extraction" process, which purifies the output for human consumption.  Turnaround time tends to be a month.  Since the production fix occurred midway during the quarter some of the increased volume might not get shipped by December 31.  If a favorable turnaround is achieved a stronger performance is possible.

Any unfilled orders will be delivered in Q4 (March).  That quarter usually is Cyanotech's low point, due to the short days (less sunlight).  Still, output per acre has been improving with the exception of the recent Spirulina setback.  So another favorable comparison is likely in that period, as well.  Our full year earnings estimate is unchanged at $.40 a share.

Higher average selling prices should expand margins in fiscal 2014 (March).  Marketing costs probably will continue to rise.  But selling prices to retail chains tend to be 2x-3x higher than in the bulk channel.  Cyanotech is creating multiple products to address that market, moreover, creating the potential for greater revenues per store.  Demand continues to accelerate for Astaxanthin and Spirulina, fueled by athletes who use the products for energy and recovery, and health conscious consumers seeking immunity from disease, better eyesight, and sunburn protection, among other things.  We estimate revenues will advance 29% next year to $36 million, providing earnings of $.65 a share (+62%).

A key lawsuit seems to be going Cyanotech's way.  One of its bulk customers sued the company earlier in the year over patent infringement.  In reply Cyanotech completed its existing supply contract, but declined to renew it.  That output was diverted to other customers, which are willing to pay higher rates.  The litigant failed to show it even had a patent during the trial's discovery stage.  That company has been extracting settlements from other industry participants for several years with its non-existent intellectual property.  Cyanotech was the first to fight back.  A settlement remains possible but at this point it looks like the whole thing might be dropped for lack of evidence.

Physical expansion is in the pipeline.  Space is available in the office park in Hawaii where Cyanotech operates.  Additional growing capacity probably will be added on a sequential basis over the next several years. 

In 2-3 years sales could attain $50 million to support income of $1.00 a share.  Applying a P/E multiple of 15x suggests a target price of $15 a share, potential appreciation of 200% from the current quote.  Product line extensions, broader retail distribution, and production expansion could yield a substantially stronger showing.

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