Why has Burning Rock Biotech, which has long been overlooked, suddenly become popular?

Cancer detection company Burning Rock Biotech saw a slight increase in revenue in the third quarter, while gross margin surged nearly 4 percentage points.

Key Points:

• Burning Rock Biotech's revenue in the third quarter grew by 2.3% year-on-year, mainly due to a significant increase in revenue from R&D services, offsetting the decline in cancer detection products.
• The company's stock price has doubled this year and rose another 33% in the week following the latest earnings announcement.

Yang Ge

The Chinese stock market's strong year is coming to a close, and this time we will take a deep dive into the latest performance of cancer diagnostics company Burning Rock Biotech (BNR.US). The company is one of the few stocks that have performed exceptionally well this year. We previously referred to such stocks as "Chinese Easter eggs," as they appear to have good growth prospects but have long been overlooked by investors.

However, the situation for Burning Rock Biotech is not so clear-cut. Since its listing in New York in 2020, the company has continued to incur losses, and its revenue growth has not been rapid. The most reasonable explanation for its stock price doubling this year seems to be its enviable high gross margin, far ahead of its global peers. Nevertheless, the company's large operating expenses still keep Burning Rock Biotech deeply in the red.

Although the company continued to report losses in the third quarter, the extent of the losses narrowed significantly, indicating that Burning Rock Biotech may not be far from entering the "promised land" of profitability. Since a considerable portion of the company's expenses are non-cash items, such as stock-based compensation and depreciation, there is no risk of cash flow tightening in the short term, alleviating one concern for investors.

Regardless of the reasons, investors are clearly enthusiastic about the company's latest financial report released last week. The stock price rose by about one-third in the following five trading days, reaching a two-year high, with a market capitalization of $230 million.

Aside from Burning Rock Biotech's enviable high gross margin, there are several other positive developments that can explain the recent enthusiasm from investors, which will be explained one by one later. However, the significant rise in stock price this year may simply stem from investors "rediscovering" the company after years of neglect. Even though the stock price has risen 207% this year, the company's current price-to-sales ratio is still only 3 times, close to France's bioMérieux (BIM.PA) at 3.17 times, but lower than the larger Thermo Fisher Scientific (TMO.US) at 5.14 times.

Burning Rock Biotech primarily produces cancer detection products, which are used by partner hospitals for in-hospital testing and also provided for individuals for home testing. Home testing products have a higher gross margin, but have been impacted over the past two years due to the business's heavy reliance on physician referrals. However, after the government tightened scrutiny on medical device companies paying referral fees to doctors, physicians significantly reduced such referrals over the past two years.

As a result, the company has tried to focus on its in-hospital testing business, which was originally growing steadily, but saw a year-on-year decline of 17.1% in the latest quarter, dropping from 63.8 million yuan to 52.8 million yuan ($7.45 million). The company attributed this decline solely to "decreased sales" without further explanation. Additionally, since Burning Rock Biotech canceled its quarterly earnings conference calls last year, investors have had no opportunity to directly ask management about the reasons

R&D Revenue Growth

The company's so-called "central laboratory business," which refers to its home testing services that require results to be sent to a central laboratory for processing, has declined by 7.9% year-on-year due to the ongoing effects of restructuring, with revenue dropping from 40 million yuan in the same period last year to 36.8 million yuan.

The only highlight for the company is the significant increase in R&D service revenue, which surged by 69%, rising from 24.9 million yuan in the same period last year to 42 million yuan. Although this seems to potentially become a new growth engine, the revenue from this segment has been quite unstable in the company's past few quarterly reports, with significant fluctuations possible from quarter to quarter.

Despite this, the substantial growth in R&D revenue still drove Burning Rock Biotech's overall revenue in the third quarter to increase by 2.3% year-on-year, from 129 million yuan in the same period last year to 132 million yuan.

The company's cost of revenue this quarter is also relatively low and has decreased year-on-year, resulting in a very impressive gross margin of 75.1% for the third quarter, an increase of nearly 4 percentage points from 71.4% in the same period last year. For comparison, bioMérieux's gross margin over the past 12 months was 56.3%, while Thermo Fisher Scientific's was even lower at only 41.3%.

However, it is unfavorable for Burning Rock Biotech that the company's expenditure level is quite high. This quarter's expenses amounted to 115 million yuan, which is about 87% of its revenue, although it has decreased by 12% compared to the same period last year. Such a large cost ultimately still dragged down the company's performance this quarter, although the net loss has significantly narrowed from 35.7 million yuan in the same period last year to 16.8 million yuan, indicating that the company may be close to achieving profitability.

Another piece of good news is that the company announced that Japan has approved some of its products for use as "companion diagnostics" for AstraZeneca's oral breast cancer drug capivasertib. However, it should be noted that Burning Rock Biotech's overall overseas business performance has not been ideal, with revenue outside of China in the third quarter only amounting to 17.2 million yuan, a significant decline from 25.8 million yuan in the same period last year.

Other "Chinese eggs" we have written about this year include wearable device manufacturer Huami Technology (ZEPP.US), whose stock price has increased ninefold since January; Xinyang Technology (SY.US), whose stock price has also doubled; and Here Group (HERE.US), formerly known as Quantum Song, whose stock price has risen by 150% this year. However, these companies all had relatively clear growth catalysts at the time, which were simply not seen by investors earlier