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Canada’s Most Undervalued Pharmaceutical Stock Is a Buy!

Knight Therapeutics (TSX:GUD) is a company within the specialty pharma industry that differentiates itself from its peers by taking on very little debt and developing products through financially savvy partnership arrangements.

The real value in Knight is the presence of brilliant CEO Jonathan Goodman, who has an incredible track record in the Canadian pharmaceutical industry. Knight has nearly zero debt and over $700 million in cash for capital allocation and business development opportunities. The key differentiator between Knight and other pharmaceutical companies is its specialty business strategy of developing profitable partnerships with other bio-technology companies to expand its product portfolio.

It is true that there are several risks with such a business model. Knight has a large fixed-income portfolio comprising a significant part of its total assets. Although this creates potential for the company to take losses due to counterparty default, it is important to note that most of the loans are secured.

Knight also depends on its early seed investments to provide an adequate rate of invested capital, so it can comfortably access opportunities with investment income. However, the company is very strong at diversifying its holdings, and the investment portfolio has historically been uncorrelated with the S&P 500. Knight is currently valued by the market slightly above net cash, which creates a tremendous buying opportunity.

Although its future success will depend on the company’s ability to extract value through portfolio investments, commercialization of product pipeline, and growth through smart acquisitions, there is no better person to help the company achieve this than Goodman, who grew Paladin Labs from scratch into a multi-billion-dollar company. His acquisition appetite likens that of the world’s greatest investor, Warren Buffett — that is, buying great companies facing temporary problems and business undervaluation.

Recently, an activist investor Meir Jakobsohn forged a proxy fight where he pointed to Goodman’s numerous conflicts of interest and criticized Knight’s low-risk business strategy. Jakobsohn pointed out that the market attributes no value in the stock of Knight for anything other than cash and financial assets, net of debt.

Jakobsohn advised several changes and proposed allocating the company’s cash hoard towards share buybacks. A shareholder vote was held where his proposals were rejected. He did, however, correctly note that the company is extremely undervalued.

Q1 2019 revenue was in line with expectations, and Knight reported holding over $700 million in cash. The company continues to develop products on an opportunistic basis that are characteristic of the value investor mindset. The company has also shifted its focus to opportunities outside Canada, specifically the U.S. and Europe, which increases diversification and reduces risk.

Knight has recently slowed the pace of acquisitions; however, it appears that Goodman is readying his cash war chest for big acquisitions or share buybacks in the future. The company’s strong balance sheet and acquisition track record sooth any activist concerns, and Goodman is well aware of Knight’s undervaluation. He has communicated to investors on several occasions that a patient and long-term approach would be best suited to holders of the company’s stock.

Expect exciting things from Knight and Goodman in the future!

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The Motley Fool owns shares of KNIGHT THERAPEUTICS INC. Fool contributor Nikhil Kumar has no position in the companies mentioned.

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