Biotech

Bhavneesh Sharma

Top 20 Ranking (28.2% Avg Return) --TipRanks

An Analysis of Karuna Therapeutics' Upcoming Phase 2 Schizophrenia Data Readout

Karuna Therapeutics (NASDAQ: KRTX) stock is trading below its recent IPO price. The company has a key price-moving data release later this year: Phase 2 data from a randomized, placebo-controlled trial of KarXT in treating patients with schizophrenia and acute exacerbation of psychosis is expected later this year (enrollment completed). After analyzing previous existing data, I am bullish on a positive outcome for this trial and plan to start a long position on Monday, adding in one-fourth increments to a maximum of 2% allocation of the capital. For the purpose of this article, I will focus on the schizophrenia part of the pipeline since it is the nearest data readout. 

Investment thesis:

KarXT is a combination of xanomeline, a muscarinic receptor agonist (preferentially stimulating M1 and M4 muscarinic receptors) and trospium, a muscarinic receptor antagonist that acts peripherally and does not measurably cross the blood-brain barrier (it is approved for treating symptoms of overactive bladder). Xanomeline was developed by Eli Lilly, who conducted a randomized, double-blind, placebo-controlled trial in 20 patients with schizophrenia and acute psychosis as monotherapy. The trial was successful in showing a significant difference of 24-points in total PANSS score difference between xanomeline and placebo, which is higher than an average of nine to ten points improvement in PANSS score showed by a meta-analysis of currently approved antipsychotic drugs. Historically, a change in PANSS score of five points has supported the approval of current antipsychotics. 

The clinical application of xanomeline in the real world is, however, limited due to its peripheral muscarinic side effects. The founders of Karuna Therapeutics licensed xanomeline from Eli Lilly and combined it with a peripheral muscarinic antagonist to create KarXT. By using this combination, the beneficial muscarinic effects of xanomeline are expected to be restricted to the central nervous system, thus maintaining the efficacy seen in the above Eli Lilly’s trial but avoiding the peripheral muscarinic side effects. Karuna has shown the proof-of-concept of safety in a Phase 1 trial where KarXT showed 46% lower cholinergic adverse events compared to xanomeline+placebo. 

I looked at the design of Phase 2, randomized, placebo-controlled trial in schizophrenia with acute psychosis whose data is expected to be reported by year-end. The dose of xanomeline after up-titration matches that used in the above mentioned Eli Lilly’s trial. The trial size is adequate, enrolling a total of 182 patients (91 in each of the two arms) compared to just 20 in Eli Lilly’s trial. The treatment duration is 5 weeks which is adequate considering the 4-week treatment duration in Eli Lilly’s trial. The primary endpoint is also similar to Eli Lilly’s trial: a change in total PANSS score from baseline vs. placebo. In addition, the trial is also exploring an effect on the negative symptoms of schizophrenia using the PANSS Marder Factor score (negative symptoms of schizophrenia are very difficult to treat using currently approved antipsychotic drugs and this is an active area of research by various pharmaceutical companies). From a safety point of view, so far, no safety signal has been found and two reviews by the Interim Safety Monitoring Committee have recommended continuing the trial without modification. 

The company has a strong management with a track record, another plus point in the bullish thesis. CEO Steve Paul, M.D. served as the Executive V.P. for Science and Technology at Eli Lilly and President of the Lilly Research Laboratories. He oversaw the development of blockbuster CNS drugs like Cymbalta and Zyprexa at Eli Lilly. He is a well-known expert in CNS diseases and also acted as the Scientific Director of the National Institute of Mental Health (NIMH). He has authored over 550 research papers and book chapters. 

The company is well-funded at present with $75M in cash reserves at Q2 end. At the current operating cash use rate, I expect approx. $62M in cash reserves at Q3 end. There is no long term debt. I don’t expect any capital raise before the release of the above Phase 2 schizophrenia data. 

While schizophrenia is a crowded market, it is also a huge market with room for new, better drugs, especially those showing a fast effect and treating negative symptoms. Global sales of antipsychotic drugs exceeded $11 billion in 2015, and are expected to exceed $14 billion by 2025. Several blockbuster antipsychotic drugs like Abilify and Seroquel have exceeded a peak $5 billion in global sales. The current liquidation value of Karuna Therapeutics is approx. $62M, and the company has a market cap of $324M, thus valuing the pipeline at $262M. The pipeline is quite diverse and also includes clinical indications like Alzheimer’s disease, a target market expected to reach $10 billion of annual global sales by 2025. On a conservative side, I modeled peak $1 billion in global sales for KarXT (some sell-side analysts have modeled peak revenues for KarXT as high as $2 billion to $ 4 billion). After probability-adjustment for the current stage of development, my estimate for the fair value of equity is $600M, thus providing a first price target of $25/share (minimum 2-year timeframe). The stock is showing signs of recovery from its recent downtrend and was up >6% on Friday. I expect a buying interest as we get closer to the Q4 schizophrenia data.

Rating: Buy

Price target = $25/share (minimum 2 year timeframe)

Suggested allocation = 2% of the capital in one-fourth increments.


A pasted image

(Karuna Therapeutics, complete R&D pipeline)


Risks in the investment include disappointing data which may lead to a sell-off. The efficacy data in this Phase 2 schizophrenia trial may not match the efficacy shown in the earlier trial or unexpected side effects may be seen. Investing in developmental stage pharmaceutical companies is risky and may not be suitable for all investors. It is also possible to lose the entire capital invested. The company is also expected to need more capital before any product reaches the commercialization stage and this may put downward pressure on the stock price.

Disclaimer:

This article represents my own opinion and is not a substitute for professional investment advice. It does not represent a solicitation to buy or sell any security. Investors should do their own research and consult their financial advisor before making any investment. Investing in equities, especially biotech stocks has the risk of significant losses and may not be suitable for all investors. While the sources of information and data in this article have been checked, their accuracy cannot be completely guaranteed.

I/we have no position in KRTX but will buy a long position over the next 72 hours. 

Bhavneesh Sharma covers biotech as one of the original contributing analysts at FATRADER. A market expert with a medical degree and MBA, he is ranked among the top 15 financial bloggers and top 100 overall financial experts (including Wall Street analysts) on TipRanks.
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