Race Oncology & the improving fortunes of the global Chip sector

Race Oncology & The global chip sector has bottomed out.

 

This week in our Investor Webinar we discuss Race Oncology (ASX:RAC) and the improving fortunes of the global chip sector:

• The RAC share price seems to be bottoming out. So, is this a good time to jump on this stock?
• The Philadelphia Semiconductor Index (SOX) has done well recently. We think the global chip sector is on the verge of a new upcycle!

 

Speaking of semiconductors … check out our interview with Weebit Nano HERE!

 

What are the Best ASX Stocks to invest in right now?

Check our ASX buy/sell tips

 

TRANSCRIPTION

 

Marc: Good morning. It’s the 8th of November. Yesterday we had the race that stops the nation, today, Stuart, we’re talking about a different type of race.

Stuart: Yeah. This is the drug that stops the whole world, namely bisantrene for the treatment of acute myeloid leukemia being developed by Race Oncology. So, Marc our cousins at Pitt Street Research have written some pretty good research on Race Oncology a few months ago. So, I’ll just recap what this company does, and then we’ll talk about the data they’ve just got. The first thing to notice is that the Race shareholders have not done well in 2023. But Marc, take a look at the tail end of that chart, middle of August till about now. That looks like a pretty good base-building situation. Would you agree?

Marc: Yeah. It’s still range-bound but it seems that maybe the downtrend has been broken, and yeah, consolidation is usually the first step for stock to find its way back up again.

Stuart: Right. Interest rates have been going up all around the world. We had an interest rate increase yesterday in Australia to celebrate Cup Day with. But the consensus is that the cycles more or less peaked. When that happens, you’re gonna see cash coming back into risk assets. And from an American perspective biotech is it. And you can see the next slide, what I mean there. That’s the NASDAQ Biotech Index, had a pretty torrid 2022, 2023 wasn’t much better, but it’s recovered quite nicely in just the last few days. So, I’d wanna see it go a bit higher. But I think the downtrend that you can detect on that chart beginning in June is probably coming to an end. So, I’d watch that carefully. But what it means is potentially drug developers down here, like Race Oncology, have a shot at recovering in 2024.

In Race’s case, there’s some decent data and a fair bit of maturity to back that up. So, let’s talk about Race Oncology. Based here in Sydney. What do they do? They’re re-profiling an old cancer drug called bisantrene. In drug development, re-profiling a drug is where you take a drug that was around for something else and re-profile it into something new. It happens all the time because scientists have a habit of discovering new uses for particular drugs. Bisantrene is particularly interesting. In the ’80s, it was the hot new thing in certain cancers. And it was actually developed and put on the market in France by one particular drug company. But if you trace through the various pharma merges that were going on in the ’80s this drug kind of disappeared from view.

And at the time, there were other drugs coming on the market for the treatment. It was not just for acute myeloid leukemia, but other cancers that looked better and safer. And so, this drug kinda died a death with no one really noticing it. However, a couple of guys did. Dr. John Rothman and Dr. Bill Garner over in the U.S. Bill Garner, I’ve known for a number of years, he’s a very talented U.S. bio entrepreneur. They realized that this drug had died, but not because of any serious problems with the drug. So, they filed some new patents around the use of bisantrene and then set to work with the re-profiling exercise. Race Oncology was the fruits of that. They took it public on ASX in July 2016. The IPO at the time was 20 cents. And Marc, if you dig through the internet, you might find the research report that I wrote in 2016, which would support that effort way back at 20 cents. So, I’ve got quite a history with this company. Meantime, thanks to some pretty good clinical data and other things, the stocks actually re-wrote quite nicely, made it to $3.70 back in 2021. Comeback since then is now $1.02. But it’s holding pretty steady in that channel we saw a few charts ago.

What’s good right now? Well, the phase two data that they’ve been collecting in acute myeloid leukemia looks interesting. A lot of the early work on this company, in fact, the original data that propelled the stock into the stratosphere was done by the Sheba Medical Center in Tel-Aviv, in Israel. They’ve gone back and run another study where they’ve combined bisantrene with two standard-of-care drugs, fludarabine and clofarabine. And what they’re finding is a decent response rate in patients with advanced relapsed or refractory. So, once you get to relapsed and refractory, you’re getting pretty sick. So, to get a response in these kind of patients is quite good. But the important thing is this, and the reason why the founders of Race picked this idea up back in the last decade or so, the drug has no cardiotoxicity.

A lot of drugs will cause a lot of damage to the heart. They’ll treat the cancer, but they’ll also shorten your life through weakening the heart muscles. This drug doesn’t have that problem. And so, when you combine it with the fact that you’re getting such good responses, bisantrene actually has a decent future. And that data will be presented at the American Society of Hematology meeting, which happens next month in San Diego. So, Marc, can I take some money out of our account and fly to San Diego to attend the American Society of Hematology Conference? Because this sounds interesting.

Marc: Yeah, you can only if I can join you for some beach volleyball on Mission Beach.

Stuart: So, if there’s any hematology conferences in less salubrious locations, I guess I’m going alone, right?

Marc: Yeah, probably. Yeah.

Stuart: All right.

Marc: And you’re staying in budget hotels as well and flying cargo holds, so…

Stuart: All right. So, now this is where the story gets a little bit, I won’t say complicated, but there are a few nuances that you need to appreciate as to why this story is so powerful. And the first one is FTO. FTO stands for fat mass and obesity-associated protein. Biologists have a way of naming molecules for all sorts of interesting properties. Turns out, as you can appreciate, this particular molecule was associated with fat and obesity. When scientists looked at the particular molecule, they also found it was a cancer marker. When that particular protein was messed about with, it was causing certain kinds of cancers. Long after Race went public, the mechanism of action of the drug working via this FTO protein was identified. And once you understand the mechanism of something, you can go look at other cancers where this is relevant and spread the usage of the drug around.

So, the thing to understand about Race, acute myeloid leukemia is not necessarily where it’s at. This has become quite a well-treated cancer in the last seven years or so. So, it’s less and less likely that patients will die of acute myeloid leukemia in the future. And those patients who get it will have longer five years of survival or higher levels of five-year survival. In this data that the Sheba Medical Center just gathered, those patients did well enough in many cases go into a bone marrow transplant. Once you get a bone marrow transplant in a disease like AML, you’re potentially cured. So, that’s just one piece of data. There are other drugs out there that are really good for AML.

So, it’s getting a little bit crowded to think of bisantrene as being useful in AML, although it probably is useful given the fact that it acts against cardiotoxicity. What the company is talking about now is going after other cancers, in particular metastatic breast cancer, where some of the other drugs that are treated for that indication are actually cardiotoxic. You could select women whose breast cancer was FTO-positive. And so, you have a subgroup potentially that could do quite well with this disease. That’s what’s being explored at the moment. But the phase two data gives you more comfort factor that this company is not headed for a clinical failure. It’s really just gotta pick the indication it’s going after correctly. And I think that’s what the market is saying in terms of where the share price is. They’re not gonna market down any further, and they’re probably waiting for a good excuse to rewrite this one given the power of the drug.

Marc: Right. And so, everything in life sciences takes forever, right? So, the obvious question is, what does the balance sheet look like? And they probably need some more capital, right? Before they…

Stuart: Yeah, they’ve got enough cash to go for a while because they raised a fair bit back when the stock re-rated quite heavily in 2020, 2021. They obviously will be back for more in the future. So, you need to time that one carefully. The pathway here is how fast they can get onto some of these newer indications and that will then drive a fair bit of news flow. So, if you don’t own the stock, I mean, I’d be careful buying it right now, until it became clear what the pathway was going forward. But I think it’s a very interesting story. Now, analyst bias, Marc, you know me very well, I never met a biotech I didn’t like. That’s why everyone in the biotech sector likes me because I’m more inclined to say nice things about them than unkind things. But I can see a lot of good qualities in this one. And there’s a reason why it’s re-rated from the lowly levels of 20 cents that it was IPO’ed back in 2016.

Marc: All right, good stuff. Now, to another sector where stuff usually takes quite long if you’re developing new things, which is the chip industry. And the reason to have a look at that one is because the Philadelphia Semiconductor Index, which is basically the index to look at if you wanna keep track of how chip stocks are doing, that’s actually gone up quite nicely very recently. So, the question…

Stuart: So, Marc, are you sure about this, like, things take forever? I go into the grocery store all the time, and when I get to the chip section, there’s always something new on the shelves.

Marc: Yeah. And then nice flavors as well, right?

Stuart: Right. So, we’re talking about semiconductors here, right?

Marc: Definitely. All right.

Stuart: Yeah, I really better pay attention.

Marc: So, let’s have a look at the Philadelphia Semiconductor Index. So, stocks for short, what is it? It’s 30 U.S.-listed chip stocks, semiconductor stocks for those who didn’t get that the first time around, Stuart. And these are…

Stuart: Why is it called the Philadelphia Semiconductor Index?

Marc: It was created back in ’93, probably in Philadelphia, I have no clue. NASDAQ owns it. And it’s a good indicator of how the industry is doing, at least in terms of share prices. You have to be listed in the U.S. to be part of this group. But you don’t have to be a U.S. company. So, if you look at that list over there most of them are U.S. companies, but AML is Dutch, TSMC is Taiwanese

Stuart: And Wolfspeed is European as well, right?

Marc: Wolfspeed is a U.S.-based company but they’ve got facilities in Europe. And GlobalFoundries is basically the product of a few mergers and spinoffs over the years. But they’re all listed in the U.S., but they don’t all have their own chip facilities. For instance, NVIDIA, Broadcom, those are fabulous chip companies. So, they design the chips and then have companies like TSMC manufacture them for them, or GlobalFoundries, that’s another chip foundry. ASML is an equipment company, the same as Applied Material. So, it’s a whole mixed bag and a good sort of cross-section of the industry.

Stuart: And just one more question to satisfy my curiosity. How come Taiwan is so good at semiconductors? You talk about TSMC, but that’s not the only player. There are others. And a lot of these fabulous companies we’re talking about are based in Taiwan. What’s the secret of their success?

Marc: Well, if you go back in time, the semiconductor technology emerged out of the U.S. But technology itself was used also to help certain Asian countries post-Second World War. So, in the ’60s and ’70s to help them in their economy. So, Japan, Korea, Taiwan, were all companies that quickly adopted the technology and got licenses from U.S. companies, including Intel and Fairchild Semiconductor. And they built up their own industries, and they did it so well that in some instances, like with the case of TSMC, it’s not the biggest foundry in the world. They did it so well that they basically surpassed their U.S. peers over time.

Stuart: Right. Uncle Sam’s not gonna be so helpful in the future, right?

Marc: Well, this is a different discussion, but Uncle Sam is implementing a few restrictions at least here on China, but that’s a whole different discussion. So, the SOX, this goes back to inception, ’94 it was first traded. You can see it’s had quite a nice run from the GFC onward. And of course, you can see the Dot Com bubble in there. The chip SOX were booming. 9/11 in there. Of course, the COVID crash. But you can see in hindsight how short-lived all these crashes were, right? So, because chips semiconductors are the proliferation of that has only accelerated over the last sort of 15, 20 years, my bet is that going forward, say until 2040, 2050, this sector will keep on this trajectory where any crash, any pullback will be relatively short-lived. Because yeah, there’s just too much demand. Semiconductors power everything these days. And so, the sector will benefit from that in the next couple of decades.

So, if we look at more recently. So, this goes back to last year. So, 2022 was a horrific year, same as for life sciences. Interest rates in March of ’22 were jacked up by the Fed. So, this entire sector has come down. It’s bounced back since late last year. But right now, after that initial recovery, there was a bit of a doubt I’d say about where, you know, the interest rates are going, how the U.S. economy is playing out. I think we’re probably looking at peak interest rates for the U.S., maybe not Australia, but definitely for the U.S. And so, you can see just in the last week or two that the SOX has actually recovered. You know, still in that downtrend.

But my guess is that we’ll be very close to the end of that downtrend for a number of reasons. The key reasons, obviously, is that the sector fundamentals seem to be improving. So, if you look at the major DRAM manufacturers, so SK hynix, for instance, is one of them. But also flash memory, Samsung is a big player in that. They’ve been seeing price improvements for about two months now. And so, the articles that you see on the left, those are from yesterday. Basically, what they’re saying is, “Look, we’ve seen very weak demand recently. We cut back production, but now our inventories are back to well getting lower and lower, and we’re now seeing price increases.” And that’s actually led to a nice sort of mini bull run in some of these chip stocks. And actually this morning, Global Foundries came out with great results as well. And that stock is booming as well now. So, what you’re seeing is that the initial mover in this market is always memory. Memory is always the first to move when things go up or down. And we’re now seeing memory price is starting to improve. And my bet…

Stuart: Why is that? Why does memory move first?

Marc: It’s just a very boom-bust type dynamic. Production dynamics are very different from logic, which is the other big segment of the semiconductor market. Logic is sort of, you know, the smart chips, if you will. Memory is just for storage, and it’s basically a commodity. So, as soon as there’s overcapacity you’ll see prices come down really hard. But also the other way around when there are shortages, these prices just spike. So, it’s really a leading indicator for the logic market. So, I think early next year, early 2024, we’ll see logic following as well. And that could potentially be supported by initial rate cuts in the U.S., which will be good for equities in general, but also, you know, in terms of risk profiles. You’ll see probably some money flow back to the semiconductor industry. So, in an environment like that, where we’re really on the cusp of a recovery of the next upcycle in semiconductors, what stocks do we like? Well, it’s usually safe to go with the leaders in their field. And so, in a few respective fields, equipment, fabless, and foundry, we like ASML chip, one of the leading chip equipment manufacturers and the monopolist when it comes to lithography, which is a key manufacturing step in semiconductors. NVIDIA…

Stuart: Yeah, well it’s good to invest in a monopoly.

Marc: What’s that?

Stuart: Always good to invest in a monopoly.

Marc: Yeah, definitely. And so, NVIDIA, everyone these days knows NVIDIA, the leader in AI chips, it’s a fabless chip company, and TSMC does most of their, if not all of their production work. TSMC is the largest foundry. And it’s by far the leader in most advanced production as well. So, at three nanometers. So, just briefly on ASML. This is the best company you’ve never heard of as a regular Aussie investor, but it’s definitely one that you want to be aware of. If you look at the chart on the left there, you can see the improvements the company’s made in terms of share price, but that’s all driven by the fact that it’s, by far, the technology leader in lithography, which is a production step to print the chip patterns on silicon. And we won’t go into that now, but that’s a clear leader in its field.

It’s got an 80% market share in DUV, and it’s a monopolist in EUV, which is the most advanced production equipment. So, if you’re a chip manufacturer, you have to go ASML if you wanna be competitive. ’24 will likely be a transition year in terms of the numbers because it’s coming down. Still, people have pushed out their equipment orders for ’23 that will likely persist into ’24, not the whole year, but coming into ’24, we’ll still see some weakness. But if you look at ’25 the valuation is insanely attractive in my book, because for this monopolist in EUV, you’re only paying 0.44 on the beloved EV/EBITDA-to-EBITDA-growth metric, which is really, really low in my book. The biggest risk here is that ASML sees a big chunk of the China business disappear because of the more restrictions that are coming in.

So, Trump, a couple of years ago, limited or basically had the Dutch government ban ASML from exporting EUV, which is the most advanced equipment, but the Biden government has come back and said, “Look, guys, you should not really export the most advanced DUV technology.” So, that’s coming into effect later this year. And if you look at ASML’s revenues in 2023, you can see the China portion of that really growing because all these manufacturers in China were hastily, you know, ordering new tools from ASML before these restrictions kicked in, right? So, next year that will be a lot less. But if you look at the chart on the right, that’s the more short-term chart, we think this one can definitely go back to the upper range of that trend line, which is above $1,000. This is the NASDAQ-listed version of ASML. It’s also listed in Europe, Euronext, but this is the U.S. So, there’s a lot of upsides, and in my book, if you buy this one, you should be good for another 10, 20 years for this one, because it’s simply the most advanced must-have equipment out there in the market for lithography.

Stuart: So, Marc, would you say that the Biden administration’s restrictions when they were announced were actually a great buying opportunity because you could get the sense they would grow beyond that temporary restriction?

Marc: Yeah, look, it’s a bit of a mixed bag because you’ll see some China business disappear. On the other hand, if you look at the effects of the Chips Act which basically says, “Look, we need more onshore production of chips. We need to pull it back from Taiwan because of the risks of China invading that at some point.” What that means is that a lot of manufacturing is now going back to the U.S., to Europe, to Japan, and to Korea, right? So, away from Taiwan, still owned in large part by TSMC, but it’s setting up fabs outside of Taiwan, which means that if you’re not sort of centralized in Taiwan so these fabs are more dispersed, you’re less efficient. You still need all these tools from all these equipment manufacturers. So, for equipment manufacturers like ASML, it’s actually not that bad, but that’s in the longer term, right? Once these fabs are close to being outfitted with equipment. So, give it another like two, three years. So, you’ll have more diversification in terms of where chips are produced in the long term. And that in itself, I think is probably good for chip equipment companies.

So, NVIDIA, everyone knows NVIDIA because of the spikes earlier this year. The company far exceeded its own guidance and the share price spikes. It’s a market leader in graphic chips, but these chips… And if you go back to the chart this is sort of 2015, 2016. If you look at the chart on the left, go back in time a bit, a lot of these chips were all of a sudden used for bitcoin mining. Initially, they were graphic chips for gaming. But bitcoin miners found out that these GPUs are very efficient in processing their data, right? So, in mining bitcoin. So, all of a sudden you see in the chart there, NVIDIA shares are taking off because, you know, they’re selling more of these GPUs into the bitcoin mining sector, I should say.

Well, a couple of years ago, the artificial intelligence applications of these chips have also come into focus. And that’s what’s really driving the share price at the moment. Of course, you can use these chips for everything from gaming data centers, automotive, industrial, et cetera. But AI is the big sort of driver at the moment. And if you look at the revenue projections from this year to 2025, it’s compounded, or the average one for those 2 years is 72%, which is massive, of course. And EBITDA is expected to grow almost 400% next financial year which starts in February. And then again, coming back to our preferred valuation metric EV/EBITDA-to-EBITDA-growth, you’re paying 0.1 basically for this one, which is extremely low because, in that metric, we basically relate the valuation to the growth that you’re buying for that valuation.

And so, it’s really low. My book, still for 2025, it’s only 0.7. Anything below one is pretty attractive. But yeah, in this case, it’s 0.1 for next year and 0.7 for ’25. So, I think that looks really good. The key risk with this one is because they don’t manufacture their own chips, they’re dependent on companies like TSMC to do that for them. If these foundry partners can keep up with all the demand, especially next year when I think we’ll see a recovery in logic chips. So, demand for foundry capacity will increase. And the question then is, you know, all the demand, where is that being manufactured? And so, it might be a bit tight for capacity, not early next year, but maybe later on in the year. But yeah, that’s a risk to keep in mind.

I think for now, looking at the right-hand chart you see a bit of a gap there, that little circle. So, there’s a bit of pullback risk for the chart, but I think longer term, this is a really good stock to own even at the current share price levels. And lastly, TSMC, the world’s biggest foundry, again if you look at the share price over the long term, they’re on the left. It’s had a massive run. And you can see the double top there, that’s the COVID peak when there was shortages for all sorts of semiconductors. More recently the chart on the right, you see that after a double peak, it’s come down, it’s close to the low end of the trading range, which is good.

That’s it’s circle there. So, I think right now could be a good time to get into that stock. And again, looking at valuation, it’s 0.32 on our EV/EBITDA-to-EBITDA-growth metric with EBITDA margins of 69%. So, again, if you look at a stock here that is pretty cheap because investors are a bit scared to jump in at the moment. Interest rates are high, we might see another raise, or it could be flat, but uncertainty in the market, I think is what’s keeping investors back a little bit. And of course, the big, big, big risk for this one is the China risk. So, all the warmongering, all the talk of getting Taiwan back into the fold in China, yeah, that is a “Clear and Present Danger,” as one movie was called a long time ago.

And it’s a very real scenario where Taiwan gets invaded and that will disrupt the entire industry. But of course, specifically TSMC. So, that’s a risk with that one. But overall this sector is live and kicking, and happy days are almost back, I think, starting with memory, but logic will follow next year. So, in my book, you need to get set while you can, because, at some point, the investors in this industry look about six to nine months ahead, right? So, this is going to move before you actually see these improvements coming through. And I think probably now is a good time to jump in, Stuart.

Stuart: And Marc, TSMC, obviously you put the stock ticket from Taipei there, but it’s traded on NASDAQ as well, right?

Marc: Exactly. Yeah, you can buy it on NASDAQ as well. Yeah, that’s true for all these stocks. And I think we’ll have to wrap it up there, Stuart. Any final comments from you on this beautiful day?

Stuart: So, basically 2023 has not been a great year for markets generally, for reasons that we’ve talked about in this interview. Marc, I get the sense of it that 2024 is gonna be better. You’ll see a turnaround in sentiment once we’ve realized the world’s not falling apart, at least in an economic sense from peak interest rates. So, as we get ready for 2024, investors sort of keep that in mind. There’s gonna be a bottoming out at some point that’s coming sooner rather than later.

Marc: Yeah, I agree. And so, interest rates will be very important there. I think these conflicts in Ukraine and Israel, hopefully that gets put to bed, hopefully real soon. But I’m a bit more fearful for Ukraine in that respect. But yeah, I think there’s a lot of things going on in the world right now that have put investors on edge. And I think from that point of view, things should be improving next year. So, hopefully, we can see that come through sooner rather than later. And I guess on that note, we’ve been talking for a long time, Stuart, especially me, we should wrap it up here.

Stuart: All right, stay bold.

Marc: Yeah, thanks everyone for watching. See you next week.