Why I Sold Faron Pharmaceuticals Oy (LON:FARN)

Faron Pharmaceuticals Oy (AIM:FARN) has been on my radar for a while, and I’ve been consistently disappointed in its investment thesis. The biggest risks I see are around the sustainability of its future growth, the opportunity cost of investing in the stock accounting for the returns I could have gotten in other peers, and its cash-to-debt management. Whether a company has a good future, in terms of its business operation and financial health, is an important question to address.

Faron Pharmaceuticals Oy operates as a clinical stage drug discovery and development company in Finland. Since starting in 2003 in Finland, the company has now grown to a market cap of UK£255.98M.

The first thing that struck me was the pessimistic outlook for FARN. A consensus of GB biotechnology analysts covering the stock indicates that its revenue level is expected to decline by 845.04% over the next financial year. In addition to this, FARN is currently loss-making, delivering a recent bottom-line of -€12.82M. With a declining top-line, moving towards positive earnings becomes harder, which is a concerning issue.

AIM:FARN Future Profit Mar 27th 18
AIM:FARN Future Profit Mar 27th 18

FARN’s financial status is a key element to determine whether or not it is a risky investment – a key aspect most investors overlook when they focus too much on growth. A big red-siren warning for FARN is its low level of cash generated from its core operating activities. Given its debt level is relatively minimal (-523.13% of equity), the fact that FARN’s cash only covers a mere -523.13% of debt makes me worry. However, management has been able to reduce debt over the past five years, and it generates enough interest income to cover interest payments. Cash management is still not optimal and should be improved, but its overall debt level and interest coverage somewhat reduces my concerns around the sustainability of the business going forward. FARN has high near term liquidity, with short term assets (cash and other liquid assets) amply covering upcoming one-year liabilities, as well as long-term commitments. One reason I do like FARN as a business is its low level of fixed assets on its balance sheet (9.46% of total assets). When I think about the worst-case scenario in order to assess the downside, such as a downturn or bankruptcy, physical assets and inventory will be hard to liquidate and redistribute back to investors. FARN has virtually no fixed assets, which minimizes its downside risk.

The current share price for FARN is UK£8.25. With 31.03 million shares, that’s a UK£255.98M market cap, which is too high compared to its peers based on its industry and adjusted for its asset level. Currently, it’s overvalued by 516.48%, with a PB ratio of 27.17x vs. the industry average of 4.41x.

FARN is a fast-fail research for me. Good companies should have good financials to match, which isn’t the case here. Given investors have limited time to analyze a universe of stocks, FARN doesn’t make the cut for a deeper dive. For all the charts illustrating this analysis, take a look at the Simply Wall St platform, which is where I’ve taken my data from.