Ceapro Inc. Report

Ceapro Inc.

Results had turned sharply downwards in 2017 and 2018 after a period of rapidly increasing revenues and especially earnings per share from 2013 to 2016. Revenue per share growth resumed in 2019. Earnings turned sharply higher in 2020, 2021 and 2022 But then revenues and especially earnings per sharp turned very sharply lower in the first nine months of 2023. The company is focused on investing in research and views its existing profitable base business which involves selling certain ingredients to the cosmetics industry as a way to fund its research into what it hopes will be more profitable products. The reason book value increased sharply back in 2016 but that was due to a share issuance at a price well above book value. To date its research has not panned out in anything commercial but it claims to have several promising irons in the fire. Now the company is proposing a merger with another company and this along with the revenue decline has very much clouded the outlook.

Ceapro Inc. (CZO, Venture)  
Report Author(s): InvestorsFriend Inc. Analyst(s)
Author(s)’ disclosure of share ownership:  The Author(s) hold shares
Based on financials from: Dec ’22 Y.E. + Q3 ’23
Last updated: January 26, 2024
Share Price At Date of Last Update:  $                                   0.16
Currency: $ Canadian
Generic Rating (This rating does not consider the circumstances of any individual investor and is therefore not specific advice for any individual): Highly Speculative Buy / Hold at $0.16
Qualifies as a stock that could be bought with confidence to hold for 20 years? No, it’s highly speculative
Has Wonderful Economics? Uncertain
Has Excellent and Trustworthy Management? Not certain
Likely to grow earnings per share at an attractive rate over the next decade? Not certain
Positive near-term earnings outlook? Unknown
Valuation? Attractive but speculative
SUMMARY AND RATING:   The graph for the past nine years shows a lot of volatility – earnings were sometimes negative. The value ratios have recently deteriorated badly and the only attractive ratio is the price to book value ratio. Management quality seems good in terms of the science but the ability to commercialise the science has been poor (non-existent). The insider trading signal is neutral. Executive compensation seems reasonable. The near term outlook is now very uncertain due a recent sharp sales decline and a proposed merger with another company. Possibly, something in the nature of a license deal to commercialise some of their research could occur in the medium term but that has failed to materialise for years. Cash generation in 2022 and 2021 was impressive and it then appeared that the existing products along with research grants, were generating more than enough cash to fund their research efforts. But cash flow will be negative in 2023. In the longer term, its research and product commercialization efforts may or may not result in attractive or even very attractive earnings.  They have various irons in the research fire – one or more of which may be successful and could be licensed profitably – but all of which are difficult to negotiate and take time. All their efforts always seem to be a long way from commercialization.  The wait for something to materialize from their research efforts grows tiresome. We consider this to be a higher risk investment based on the nature of  its operations and also based on the low share price (It is a penny stock range where stock prices are usually quite volatile). On a positive note, the company has no debt and so is in strong financial shape. We rate this as a Highly Speculative Buy / Hold. It’s suitable for only a modest position as a highly speculative investment which may have potential.
MACRO ENVIRONMENT: The macro environment such as interest rates and the state of the economy is probably not of much relevance to this company.
LONG TERM VALUE CREATION: There has been a long-term value destruction based on the share price. The book value per share has grown only modestly since 2015. Overall, there has been no value creation for investors.
DESCRIPTION OF BUSINESS: Ceapro Inc. is a small  “growth stage biotechnology company”. Ceapro has a line of existing cosmetic ingredient products (which it extracts from oats) which are profitable on their own but believes that its real value and future lies in the products and processes it is researching and developing. Through scientific research, it develops products or extracts from plants (currently mostly oats). It currently produces two ingredients for the cosmetics industry on a commercial scale.  Ceapro has developed (and/or purchased or licenced the rights to) certain proprietary and in some cases patented extraction and production technologies . Some of these are intended to produce commercially valuable methods to “deliver” a variety of drugs and treatments into the human body. They sell mostly (over 90%) through a single distributor and not by direct sales. The current products are used in the cosmetics and include an active ingredient in anti-aging skin creams. Brand names that contain Ceapro’s products include Neutrogena, Lubriderm, Aveeno, Jergens, Dove and others – We suspect Ceapro’s product is in one or a few but certainly not all or most of the products under these brand names. Ceapro indicates that it is the sole-source provider of ingredients in a number of products – but the purchasers can drive a hard bargain on price and the quantities needed are not large. Many or all of its newer products would require partnering with much larger companies. In 2021, geographically, sales were 66% in the U.S., 23% in Germany, 10% in China and with just 0.3% of sales in Canada.
ECONOMICS OF THE BUSINESS: The economics of the existing products appears to be reasonably good. The base business is profitable even after expensing research efforts. But the research aspect is quite risky in terms of the need to spend on research which may never materialise as commercial products. To a large degree, this company is something of a lottery ticket. But the shares are not currently pricing in any value for the potential pay-off from the research. So it may be something of a free lottery ticket.
RISKS: We suspect that the larger risks would relate to risk of spending money on developing products and processes that might never achieve therapeutic success or regulatory approvals or commercial success. There may also be risks due to product liability in spite of some insurance coverage. There may also be significant risks related to competition or to a reliance on just one key distributor (including possible bad-debt risk) and possibly on key end-use customers.
INSIDER TRADING / INSIDER HOLDING: As of July 8, 2023 there has only been no insider trades in about four years! Therefore the insider trading signal is neutral. It’s disappointing that a couple of new directors and a new Revenue Officer have not bothered to buy any shares at all. The CEO did exercise 150,000 options at ten cents back in July 2022 (lucky him) and kept the acquired shares and now holds about 1.5 million shares.
WARREN BUFFETT’s CRITERIA: Buffett indicates that all investments must pass four key tests: the business is  simple to understand and predict (Fail, because most investors would have no familiarity with the company’s products or its risks), has favorable long-term economics due to cost advantages or superior brand power (marginal pass), apparently able and trustworthy management (marginal pass at best given some concerns about disclosure despite the credentials of management and the Board), a sensible price – below its intrinsic value (pass although it is difficult to know), Other criteria that have been attributed to Buffett include: a low  debt ratio (pass), good recent profit history (fail) little chance of permanent loss of the investors capital (pass) a low level of maintenance type capital spending required to maintain existing operations excluding growth (pass) Overall, the company does poorly on these tenets.
MOST RECENT EARNINGS AND SALES TREND: It should be noted that as a research-oriented company the current revenues and earnings may not be the most important indicators of value. In addition revenues have been somewhat volatile due to timing issues and earnings are quite volatile due to revenue timing plus varying levels of grant funding and FX impacts. For  the full year 2022 revenues per share were up 10%. Unfortunately, revenues per share have recently plummeted. In the most recent four quarters starting with Q3 2023 and going back the decline has been 32%, 66%!, 43% and 6%. It may be that customers stocked in the first half of 2022. Earnings per share were up 31% in 2022 but earnings turned negative in the latest four quarters. In Q1 2023 earnings were negative partly due to a sharp increase in general and administration expenses due to some director stock options and a some unusual legal fees. In Q2 and Q3, lower revenues along with higher costs and unusually high legal fees led to losses. Earnings per share had been small and fluctuated around  zero but did increase sharply in 2020 to a reasonably attractive level and increased an additional 19% in 2021 and were up 31% in 2022 but then turned negative in the past four quarters.  Overall, the revenue and earnings trend is now extremely negative.
Earnings Growth Scenario and Justifiable P/E: With negative profits in the trailing year and plunging revenues earnings provide no guidance to valuation at this time.
VALUE RATIOS: Analysed at a share price of $0.44. As a research oriented company, value ratios provide only limited guidance and in theory understate the value. After several years of GAAP losses, the company was nicely profitable in 2020 and again in 2021 and 2022 but has now reported losses in the last four quarters along with plunging revenues. It could be argued that (most of) its research and development expenses are actually creating valuable assets and therefore are more in the nature of investments than expenses – however that research never seems to payoff despite many years of promises. The P/E is now negative as is the ROE!  The price to book value ratio is, in isolation,  quite attractive at 0.42 particularly considering its cash which amounts to 15 cents per share or close to the current share price. There is  no dividend. Overall the value ratios indicate a highly speculative company. The price to book value ratio is the only attractive ratio.
TAXATION FOR SHARE OWNERS: Nothing unusual to note.  
Symbol and Exchange: CZO.V, Toronto Venture
Currency: $ Canadian
Contact: czo@jtcir.com
Web-site: www.ceapro.com
Latest four quarters annual sales $ millions: $11.3
Latest four quarters annual earnings $ millions: $(2.8)
P/E ratio based on latest four quarters earnings: negative
Latest four quarters annual earnings, adjusted, $ millions: $(1.7)
BASIS OR SOURCE OF ADJUSTED EARNINGS: Starting 2019 added back 75% of other income or expense which is mostly foreign exchange gains / losses Previously added back 75% (assumes 25% income tax) of plant relocations costs and foreign exchange losses or gains also deducted large periodic tax credits. Deducted a large income tax recovery in 2015. In 2018 adjusted for a gain on litigation settlement and gains on deferred taxes. Starting 2021 we are usually no longer making any adjustments because the earnings are inherently volatile and there is no real value to making adjustments. Unusual legal costs are added back in 2023. These were likely associated with a proposed merger.
Quality of Earnings Measurement and Persistence: Adjusted earnings have been volatile and positive in 2022 but then turned negative in the latest four quarters. Earnings may be under-stated due to the expensing of research and development. Non-refundable government grants are in some ways equivalent to earnings but are mostly accounted for as a reduction of capital costs or a reduction of research expenses. Cash flows in the past exceeded the earnings due the amortization of equipment and leasehold improvements as well as due to deferred income taxes in 2022.
P/E ratio based on latest four quarters earnings, adjusted negative
Latest fiscal year annual earnings: $4.4
P/E ratio based on latest fiscal year earnings: 2.8
Fiscal earnings adjusted: $4.4
P/E ratio for fiscal earnings adjusted: 2.8
Latest four quarters profit as percent of sales -14.9%
Dividend Yield: 0.0%
Price / Sales Ratio 1.11
Price to (diluted) book value ratio: 0.42
Balance Sheet: (as of Q1 2022) Assets are composed as follows: 53% is property and equipment (of which 36% is leasehold improvements and 37% is manufacturing equipment, 11% is equipment not available for use, and 14% is buildings but probably capitalised lease on buildings) , 27% cash, 13% receivables, 5% inventory, 1% prepaid expenses and 2% a longer term investment tax credit receivables. The assets are financed as follows: 90% by equity (of which 27% is retained earnings and 73% is equity raised by selling shares), 8% by capitalized lease liability, and 2% by accounts payable, 1% deferred taxes. This is a strong balance sheet with no debt  which means that the company is very unlikely to be in any financial difficulty in the foreseeable future.
Quality of Net Assets (Book Equity Value) With the company trading at 0.4 times book value (as of January 26, 2024) the quality of the assets or their realizable value could potentially  provide support to the share price independently of earnings. Given the cash, receivables and inventory the assets do provide good support for the share price at this point.
Number of Diluted common shares in millions:                                       78.3
Controlling Shareholder: No person or company owns as much as 10% of the shares and therefore the company is likely effectively controlled by management.
Market Equity Capitalization (Value) $ millions: $12.5
Percentage of assets supported by common equity: (remainder is debt or other liabilities) 88.3%
Interest-bearing debt as a percentage of common equity 0%
Current assets / current liabilities: 11.0
Liquidity and capital structure: Strong. The company now has no debt. And its cash position is strong.
Latest four quarters adjusted (if applicable) net income return on average equity: -5.4%
Latest fiscal year adjusted (if applicable) net income return on average equity: 14.8%
Adjusted (if applicable) latest four quarters return on market capitalization: -13.4%
5 years compounded growth in sales/share 6.9%
Volatility of sales growth per share:  Volatile
5 Years compounded growth in earnings/share negative past earnings
5 years compounded growth in adjusted earnings per share 33.8%
Volatility of earnings growth:  Volatile
Projected current year earnings $millions: not available
Management projected price to earnings ratio: not available
Over the last ten years, has this been a truly excellent company exhibiting strong and steady growth in revenues per share and in (adjusted)  earnings per share? No
Expected growth in EPS based on adjusted fiscal Return on equity times percent of earnings retained: 14.8%
More conservative estimate of compounded growth in earnings per share over the forecast period: 5.0%
More optimistic estimate of compounded growth in earnings per share over the forecast period: 12.0%
OUTLOOK AND AMBITIONS FOR BUSINESS: The potential merger with Aeterna has clouded the outlook greatly. Also, the outlook for the existing base business which has been profitable has recently become quite clouded due to a huge revenue decline in the past three quarters. In the medium to longer term the company expects to benefit from new products under development. It also has patents on a processing technology that it could potentially license out. It’s not clear that revenue will flow from these efforts anytime soon. However, it is possible that they would generate cash through joint venturing on the developments in some cases. Overall the near-term the outlook is for continued modest profits unless some kind of licencing deal emerges to boost earnings.
LONG TERM PREDICTABILITY: Given the technologies and development risks involved, this is not a predictable company.
Estimated present value per share: As this is an early-stage growth company it does not seem appropriate to attempt to forecast earnings.
INDUSTRY ATTRACTIVENESS: (These comments reflect the industry and the company’s particular incumbent position within that industry segment.) Michael Porter of Harvard argues that an attractive industry is one where firms are somewhat protected from competition based on the following four tests. Barriers to entry (pass due to the science required) No issues with powerful suppliers (pass). No issues with dependence on powerful customers (fail as sales are over 90% to one key wholesaler who then sells to dozens of customers), No potential for substitute products (marginal pass) No tendency to compete ruinously on price (pass). Overall this industry (the base business) appears to be attractive to a successful  incumbent in the industry – although the huge reliance on one wholesale customer is a definite concern..
COMPETITIVE ADVANTAGE: Ceapro has certain proprietary processes and intellectual property, some or all of which are protected by patents. We had understood that in some or most of its products it is the sole commercial provider. That assumption has come into question give the revenue decline in 2023.
COMPETITIVE POSITION: We did not see any information or discussion regarding its competitors or its market share. They have claimed they are the only supplier of some of their products. (Lately with their revenue plunge that is coming into question)
RECENT EVENTS: In a VERY big development, the company is proposing a merger with TSX- and NASDAQ- listed Aerterna Zentaris. Ceapro would become a subsidiary of that company and existing Ceapro shareholders would own 50% of Aeterna. The company explored but abandoned some kind of significant business opportunity in Q1 of 2023 but it was not clear what this was. In Q3 they mentioned they had canceled an engagement with an international consulting firm and that may be what the referred to in Q1. It appears that they may no longer be receiving government grants. In late April 2023 they announced the hiring of a Senior V.P. technical Operations which was indicated to be in part in preparation for commercialization of some of the companies research efforts. In 2022 they appointed a chief revenue officer which could mean that some progress in terms of licencing revenue is more imminent.    The company continues to work on various product development initiatives involving scientific research and clinical trials. Unfortunately despite several potential products, nothing appears to be imminent at all. In the 2021 Management Discussion and Analysis there was almost no discussion of the outlook for its various research efforts. As of Q1 2023 there is jargon-filled discussion of progress on various research fronts but no clarity on when any revenue will result which appears to be at least 18 months away unless a licencing deal occurs.
ACCOUNTING AND DISCLOSURE ISSUES: Overall the disclosure is quite poor. In Q3 2023 they gave what looked like an implausible reason for the big revenue decline blaming it on a lack of orders from a Chinese customer but only 9% of their sales are to China! They announced that the GM “of their subsidiary” had retired with no explanation of what part of the business they referred to.  The company tends to use excessive jargon in its reports as opposed to even attempting to use plain language. Due to accounting rules and the nature of the business there are some complexities in the accounting which make the net earnings a less reliable figure than usual. On the one hand, earnings may be under-stated due to the expensing of research and development that is intended to benefit future earnings (it arguably creates an asset).  We were impressed with the candid disclosure of government funding. However this government funding  causes the asset values to be lower than their true cost and in our view lowers the book equity and increases the reported ROE (when there are profits).  Grants are netted against the R&D expense which obscures the level of those expenses. The company should probably report in U.S. dollars since its revenues are largely in U.S. dollars. And the disclosure of the results and especially the potential of its various research efforts seems poor.
COMMON SHARE STRUCTURE USED: Normal, one vote per share.
MANAGEMENT QUALITY: Management appears to be high quality in terms of the science involved and also in terms of having built up cash and a strong balance sheet. Whether they have the skills to commercialise the science efforts remains to be seen and is looking increasingly doubtful.
Capital Allocation Skills: This remains to be seen. The determining factor will be how its investments in research pay off. The 2017 acquisition of “Juvente” appears to be a mistake given that in Q4 2018 it wrote off approximately the entire amount it paid. The assets acquired were almost entirely intangible plus a small amount of inventory. Sales from the division since 2018 have been very modest. The company downplayed the write-off as “non-cash” – and still believes the subsidiary is valuable. Yet it indicated in 2021 that the division is immaterial.
EXECUTIVE COMPENSATION: (Based on 2022 figures released in Spring of 2023) The CEO’s compensation is arguably relatively high at $0.56 million for the past two years. The CFO’s compensation is reasonable at $0.2 million for those years. The CEO’s salary was paid to his corporation as a consulting fee which is unusual and may have been an attempt to avoid or defer personal income tax. It is disturbing that the company would agree to this. There are only these two named executives.
BOARD OF DIRECTORS: Warren Buffett has suggested that ideal Board members be owner-oriented, business-savvy, interested and financially independent. (Based on the Spring 2021 circular)  The six directors appear to be highly educated including relevant technical education as well as financial education and knowledge. Two longer-standing directors own 1.1 to 1.7 million shares each. The other two long-standing directors hold 102,000 and 78,000 shares respectively.  Two newer directors elected in 2022 have not bothered to purchase any shares. Overall this appears to be a strong Board of directors. However, they may not be aggressive enough in seeking better results for the company.
Basis and Limitations of Analysis: The following applies to all the companies rated. Conclusions are based largely on achieved earnings, balance sheet strength, achieved earnings per share growth trend and industry attractiveness. We undertake a relatively detailed  analysis of the published financial statements including growth per share trends and our general view of the industry attractiveness and the company’s growth prospects. Despite this diligence our analysis is subject to limitations including the following examples. We have not met with management or discussed the long term earnings growth prospects with management. We have not reviewed all press releases. We typically have no special expertise or knowledge of the industry.
DISCLAIMER: All stock ratings presented are “generic” in nature and do not take into account the unique circumstances and risk tolerance and risk capacity of any individual. The information presented is not a recommendation for any individual to buy or sell any security. The authors are not registered investment advisors and the information presented is not to be considered investment advice to any individual. The reader should consult a registered investment advisor or registered dealer prior to making any investment decision. For ease of writing style the newsletter and articles are often written in the first person. But, legally speaking, all information and opinions are provided by InvestorsFriend Inc. and not by the authors as individuals. The author(s) of this report may have a position, as disclosed in each report. The authors’ positions may subsequently change without notice.
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