Thursday, June 27, 2013

Cyanotech ( Nasdaq - CYAN ) -- Barrels Back

Cyanotech (CYAN $5.75) reported excellent on target Q4 (March) results.  Sales improved 15% to $6.90 million.  Earnings (fully taxed) advanced 80% to $.09 a share. Figures published by the company also included a non cash deferred tax asset adjustment worth $.34 a share.  Production issues that created a setback of $.14 a share for the year were resolved during the period.  Output has been maintained at full capacity in the June quarter, moreover.  The company thinks the problems are unlikely to reoccur.  That differential alone accounts for most of the earnings improvement we are estimating for fiscal 2014 (March).  Revenues promise to advance by 20% as well to $33 million as volume rebounds and average selling prices increase.  Cyanotech traditionally sold most of its astaxanthin and spirulina in bulk for use in other companies' retail products.  Over the past few years Cyanotech has developed its own retail brand, gaining a 50% market share in the segments it serves.  Those programs are being expanded, laying the groundwork for further gains.  On average retail sales generate 200% more revenue per kilogram than bulk shipments.  Approximately 40% of the company's physical output now is sold through retail channels.  Margins could widen as the transition continues.

Capital spending is on the rise.  Several growing ponds were modified last year to produce astaxanthin, Cyanotech's fastest growing product line.  An extraction facility also is being built, to remove the key ingredients from the algae grown in the ponds.  Currently, the material is shipped to outside vendors who perform the work.  Plans are being developed to increase the number of ponds, as well.  Cyanotech borrowed money to finance the first round of capacity improvements.  If the sales and profitability outlook remains bright a stock offering could be pursued in the future.

Legal costs reduced income by $.06 a share in fiscal 2013 (March).  Cyanotech was sued for patent infringement a few years ago.  The company researched the claim and unearthed a litany of errors, casting doubt on its validity.  Costs may continue to be incurred as the battle continues, perhaps for another two years.  But the data appear persuasive in Cyanotech's favor.  Our estimates reflect a similar hit to earnings in the upcoming year.

A variety of initiatives could accelerate growth.  A new round of media publicity could bolster demand if an upcoming book about astaxanthin's benefits builds momentum.  Direct television marketing will be tested, as well.  A blitz in San Diego will be tried, in addition to that.  Cyanotech plans to duplicate the comprehensive marketing approach it already uses in Hawaii.  The 50th state is a huge user of Cyanotech's products with some estimates placing penetration at 10% of the adult population.  Success in San Diego could foreshadow a move into Los Angeles.

Cyanotech remains a high risk investment.  The nutritional supplement business is highly competitive, and consumer tastes can be whimsical.  Even well designed marketing programs can fail.  Capital requirements aren't astronomical but they are significant.  Very few companies make it big.  The ones that do succeed can make it really big, however.  Cyanotech has two exceptional products that are less vulnerable to competition than most supplements, because it has the best growing conditions and the best quality.  In 1-2 years earnings could reach $.75 a share.  Applying a P/E multiple of 20x suggests a target price of $15 a share, potential appreciation of 160% from the current quote.

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