Psychemedics Corp. (PMD, Financial) is going to enjoy spectacular earnings growth in 2016 if (now mandatory) hair tests for truck drivers are implemented. Brazil is plagued by a high accident rate involving truck drivers, possibly because some engage in drug use (amphetamines to stay awake during long-distance hauls) and/or abuse alcohol. Government has passed a law that requires truck drivers to pass a hair drug test every five years to keep their license.
There are no labs in Brazil with the capability to execute these tests, but Psychemedics has had a sales organisation called Psychemedics Brazil in the country for many years. There is information about the test on its website and it looks like its available through a wide sales network:
Once the legislation was passed by the government but its implementation deferred, the stock got hammered down to $10. Now it looks like its being implemented according to Brazilian media. It also appears the test carries a $100 price tag (likely a percentage of which sticks with the distributors/salespoints). The fee should be paid by the employers of the truckers, which will make them less price sensitive. About 13 million drivers will need to undergo testing.
Although Psychemedics has only a sliver of market share in the general market for drug testing, it's actually a leader in hair testing, which is a superior technology in many respects. Because Psychemedics has had a sales organization in the country for many years and is a leader in the segment, I expect it to grab a sizeable part of this pie. Competitors are mostly big pharma companies that aren’t dedicated to this activity. Management also anticipates strong growth as it invested in additional labs that increased their normal capex about six-fold. This, and the weakness in the energy market, has hammered earnings.
Assuming Psychemedics grabs something like 50% market share, even when I am very conservative in my calculations, Psychemedics could very well increase revenue by between $18 million and $33 million. Given the company does about $26 million in annual sales, the potential impact is enormous.
The company isn’t covered by many analysts. which makes sense given its market cap, and at first glance its fundamentals do not appear attractive: P/E of 50x, EV/EBITDA of 27x, P/B of 7x and it has net debt of $4 million to $5 million compared to an EBITDA of $3 million. Only when plotting forward earnings taking into account a normalized energy market and the Brazil expansion, this turns into a salivating opportunity.
Catalysts for the stock, other than Brazil, to get back to a level around $20 could be a recovery of the energy market and stronger employment numbers in general. The stock did run up year-to-date, but recently it has been showing some weakness which may be an opportune time to enter in anticipation of increased sales.
Disclosure: Long PMD.
