DermTech: Momentum Rising With TRICARE (NASDAQ:DMTK)

If the job has been correctly done when a common stock is purchased, the time to sell it is – almost never. – Phillip Fisher (Warren Buffett’s mentor)

Author’s Note: This is an abbreviated version of an article originally published in advance on January 16, inside Integrated BioSci Investing for our members.

In biotech investing, assessing your own risk tolerance is crucial to long-term success. That way, you’d know when to purchase shares of certain highly speculative momentum stocks. More importantly, that would let you know when to sell out. Generally speaking, the greater the risks the higher the rewards.

On that note, there is a highly speculative stock, DermTech (NASDAQ:DMTK) that is building momentum. Despite having an excellent diagnostic patch for skin cancer, recent sales growth has been modest due to various launch barriers. In this research, I’ll feature a fundamental analysis of DermTech and share with you my expectation on this interesting equity.

Figure 1: DermTech chart

About The Company

As usual, I’ll present a brief corporate overview for new investors. If you’re familiar with the firm, I suggest that you skip to the next section. Headquartered in Jolla, California, DermTech is focused on the innovation and commercialization of “precision dermatology” to fill the unmet needs of skin cancer.

At the heart of this pipeline is a non-invasive skin genomics platform. Formerly known as Pigmented Lesion Assay (i.e., PLA), the company now markets it as DermTech Melanoma Test (i.e., DMT). And, it’s being used for the detection of deadly skin cancer (melanoma). As shown below, the company is also advancing DMT for other forms of skin cancers.

Figure 2: Diagnostic pipeline

Diagnostic Melanoma Test

As DMT is the crown jewel diagnostic for DermTech, you should go over its underlying science. That way, you can better appreciate its ramifications. Accordingly, DMT assesses the pigmented or dark spots on your skin for melanoma detection. That patch technology can analyze genes mutation associated with cancer, including LINC, PRAME, and TERT. By analyzing cells at the genetic level, DMT is able to generate extremely robust accuracy.

Figure 3: Underlying science of DMT

Keep in mind, the most important metric that you should look for in a diagnostic test is “sensitivity.” While I won’t go into specific details, sensitivity tells you how well the test picks up the disease. For a diagnostic to be widely used, you can expect that its sensitivity has to be over 90%.

From the figure below, you can appreciate that DMT has a sensitivity ranging from 91 to 97%. Interestingly, the Negative Predictive Value (i.e., NPV) is over 99%. That is to say, if the DMT test shows that you don’t have melanoma, you can be confident that your chances of having melanoma are less than 1%.

Figure 4: Excellent diagnostic quality

Robust Intellectual Property Protection

Having strong intellectual property (i.e., IP) protection is crucial to your investment success. Else, a “me too” operator would wait until your product gains market traction and then jumps in to take your market share. Here, you can see that DermTech secured multiple strong patents. Hence, you can be assured that competitors are being kept at bay. Simply put, DMT has a strong “moat” as Warren Buffett would call it.

Figure 5: Strong IP protection

Tricare Coverage To Overcome Prescribing Challenge

As you know, DermTech recently gained additional insurance coverage for DMT. Precisely speaking, the company announced on January 10th that the Defense Health Agency’s Lab Joint Working Group has recommended DMT’s coverage in Tricare. As a government insurance program, Tricare covers military personnel and their families.

Due to this coverage, DermTech is adding 9 million new members. As of today, the total number of patients under coverage in the US is boosted to 113M. Of that figure, 68M is covered by Medicare/Medicare Advantage and 45M for other commercial and government payor programs. Highly enthused by the development, the Senior President of Payor Access (Dan Visage) remarked,

We’re proud to support Tricare in bringing our non-invasive melanoma test to our nation’s military heroes and their families. The DMT test results are clinically meaningful and actionable, improve patient care and reduce healthcare costs. We look forward to working with the TRICARE team to take the additional steps needed to allow for full availability of our test to its members in the next few months.

Figure 6: Medicare coverage

As you can imagine, this development is extremely important to DermTech. The problem with DMT is not that it doesn’t work. In fact, it does a stellar job as a diagnostic. The problem is that physicians are much less inclined to use it for financial reasons.

That is to say, docs have high overhead costs. They have to pay for rent, employees, and many other expenses. With DMT, they would be making less and thereby lowering their profit margin. As such, there is little to no incentive in using DMT because it reduces their revenue. Riding increasing coverage, the financial incentive to adopt DMT would be much better. After all, money always talks.

That aside, you can see that DermTech is leveraging both digital marketing and telemedicine which I believe is very important. Due to the pandemic, more patients nowadays opt into telemedicine. Moreover, digital marketing is becoming more prominent. In using both strategies, the company gives DMT a fighting chance in the launch without a partner.

Figure 7: Leveraging telemedicine for launch

Estimated Market

From the market standpoint, the melanoma market is estimated at $10B. Of that pie, Luminate and Carcinome would take the majority of the shares while DMT can still garner a significant portion. Over time, as sales of DMT ramp up, you can expect DMT to garner roughly $1B. In the long run, as Luminate and Carcinome come into play that would be very big for DermTech.

Figure 8: Estimated market

Latest Operating Results

In the latest quarterly report, revenues have been on an uptrend. The assay (i.e. DMT) revenues jumped from $2.9M to $3.4M for the same period last year. The trend in billable samples continues to increase every quarter. Going from 2Q2022 to 3Q2022, however, you can see a slight decline. In my view, it’s likely a temporary issue. Commenting on the latest operating results, the CEO (Dr. John Dobak) stated,

We achieved meaningful year-over-year billable sample volume growth, but sequential growth was flat due to headwinds caused by limited commercial payer coverage. Despite these challenges, we have more positive activity with payers now than we’ve ever had and are confident we’re on the path to meaningfully growing covered lives in the U.S. We remain closely engaged with commercial payers and believe that we’ll potentially add 30 to 40 million covered lives by the end of the first quarter of 2023 …

Figure 9: Excellent operating results

Financial Assessment

Just as you would get an annual physical for your well-being, it’s important to check the financial health of your stock. For instance, your health is affected by “blood flow” as your stock’s viability is dependent on the “cash flow.” With that in mind, you should assess the 3Q2022 earnings report for the period that ended on September 30.

As follows, DermTech procured $3.5M in revenue compared to $3.0M for the same period a year prior. On a year-over-year basis, the revenue is increased by 16.6%. That aside, the research and development (R&D) for the respective periods registered at $5.7M and $4.4M. I viewed the 29.5% R&D increase positively because the money invested today can turn into blockbuster profits. After all, you have to plant a tree to enjoy its fruits.

Additionally, there were $28.7M ($0.96 per share) net losses compared to $20.1M ($0.88 per share) net declines for the same comparison. On a per-share basis, the bottom-line depreciation widens by 9.0%. You can see that made sense due to the increased capital spent on R&D.

Figure 10: Key financial metrics

About the balance sheet, there was $152.8M in cash, equivalents, and investment. Against the $29.1M quarterly OpEx and on top of the $3.5M in quarterly revenue, there is adequate capital to fund operations into 1Q2024. Simply put, the capital is adequate relative to the burn rate.

Potential Risks

Since investment research is an imperfect science, there are always risks associated with your stock regardless of its fundamental strengths. More importantly, the risks are “growth-cycle dependent.” At this point in its life cycle, the main concern for DermTech is whether the company can overcome current headwinds to ramp up sales growth again. Additionally, there is the risk that other Precision Dermatology franchises (i.e., Luminate, Carcinome, PLA, and CTCL) won’t generate positive results to gain approval in the future.

Conclusion

Make no mistake, DermTech has a highly sophisticated and accurate diagnostic test for skin cancer. Early into the launch, sales are growing though modestly. As you know, it’s difficult to quickly ramp up sales without a robust sales/marketing partner. Nevertheless, DermTech is doing everything right to generate sales traction.

The partnership with the telemedicine provider (DermagologistOnCall) and the digital market approach is prudent. The recent Tricare coverage also adds more fuel for further growth. Despite progress, the risks for this stock remain extremely high. After all, it’s difficult to change the way physicians practice their medicine. However, if enough catalysts spark the change, the reward would be huge for both shareholders and patients alike.