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Investment Thesis
Data from Guardant Health’s (NASDAQ:GH) ECLIPSE clinical trial demonstrated disappointing results on Thursday, pushing shares down more than 30% in Friday premarket trading. The observational study, which includes 20,000 participants, examines the accuracy of the Guardant SHIELD Colorectal Cancer “CRC” screening test in detecting the presence of early-stage tumors in blood samples taken from patients with no disease symptoms.
The investigational diagnostic test has historically been considered a cornerstone for GH’s growth, underpinning its share price premium over its peers. The recent data are far less than previously estimated by the company in May, which once put SHIELD’s sensitivity around 90%. In the previous article, I argued that despite being inferior to stool-based tests, at 90% sensitivity, GH is likely to have a footing in the CRC market, given the high rates of non-adherence to stool-DNA tests from patients not so keen at handling their feces. However, the recent results, which put sensitivity at 83%, raise questions about commercialization. For this reason, this article downgrades GH from Buy to Hold.
What Happened?
The molecular diagnostic industry underwent a paradigm shift in the past few months, moving from “growth at all cost” to “profitable growth” as capital costs rose with the Fed rate hikes. It was surprising to see GH break from this trend after the Q3 earnings release showed a ramp-up in spending and cash burn, as discussed in the previous article.
Following an earnings report and what I referred to as an “aberrant trading” session, it felt that the market had reached equilibrium rewarding GH with a substantial growth premium. After all, the SHIELD study was at the late stages of development, and GH had a strong cash position, enough to cover expenses for multiple years, reducing the dilution risk seen with its peers.
However, yesterday’s data from the ECLIPSE study drove the market to change its assumptions over the commercial prospects of SHIELD. Thus, the company’s growth premium was trimmed, underpinning our rating downgrade.
How Bad Is The Data?
The ECLIPSE study found that the new blood test was 83% sensitive for detecting early-stage colorectal tumors, well below the previous estimate of around 90% released in May. The sensitivity of the test to detect adenomas was also materially lower than the data released in May (20% vs. 13%). This is a big blow for the company and many investors who have been counting on SHIELD to dominate the CRC screening market in the coming years. The initial sensitivity guidance of 96% in October last year created much hype, driving Exact Sciences (EXAS) to address the issue in previous earnings calls. Below is a table showing the efficacy of a set of CRC screening technologies.
*Based on the latest data released December 15, 2022
The impact of the disappointing data is limited to commercial prospects as opposed to regulatory risk. The ECLIPSE study outcome meets the Center for Medicare and Medicaid Services “CMS” reimbursement requirements. GH’s premarket (510-K) application (which it plans to submit in Q1 2023) is also likely to be approved because Guardant SHIELD is better than the alternative FDA-approved CRC screening blood test, Epi ProColon, which has a sensitivity of 70%, and adenoma sensitivity of 11%. Thus, it is likely that the FDA will also grant it marketing approval.
If the FDA is granting market approval for SHIELD, and the CMS is covering its cost, what is the problem? Well, regulatory approval is not a guarantee of commercial success. Even if the CMS provides coverage and the FDA grants premarket approval, adoption in the marketplace is not guaranteed. The final and most crucial hurdle to overcoming commercial success challenges is convincing physicians to prescribe the test, which ultimately comes down to Key Opinion Leaders “KOLs” incorporating it into their practice protocols. The recent ECLIPSE findings paint a bleak picture for this category of physician influencers. One example is Epi ProColon, the CRC cancer diagnostic test developed by Epigenomics, whose test is FDA-approved and CMS-covered, yet, rarely mentioned in the market because it didn’t gain acceptance from physicians and remains excluded from clinical practice guidance by KOLs.
At this point, GH ticker performance will depend on KOLs’ assessment of the tradeoffs of using Cologuard, traditional s-DNA test (i.e., FIT test), and SHIELD, balancing cost, turnaround time, and patient preference.
Summary
Investors should not expect a sharp rebound to match the recent GH stock selloff. The current ECLIPSE trial data fundamentally change the company’s growth prospects. Thus, to a great extent, the recent selloff, while significant in magnitude, reflects adjustments to its growth premiums, as discussed in previous articles. The upcoming reporting cycle will represent a modest increase in sales and earnings compared to last year, primarily because of the continued commercialization of Guardant 360 and newly-introduced LDT tests sold under the Guardant Reveal brand.
Last quarter, GH seemed to except the industry-wide paradigm shift away from “growth at all cost” as investors started demanding more explicit paths to profitability. One reason was its robust market opportunity in the CRC market. However, the commercialization prospects are now coming into question. Thus, similar to most of its peers, profitability rather than revenue growth figures will determine the ticker’s performance. With this in mind, I have a Neutral rating on the company.
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