In July, Eastman Kodak (KODK -2.12%) soared more than 1,000% on news that it would be receiving a $765 million loan under the Defense Production Act to manufacture active pharmaceutical (APIs) ingredients for generic drugs. Not even three months later, the stock is now down over 70% from all-time highs, resulting in devastating losses for investors who bought at the wrong time. There are now multiple class action lawsuits pending against Kodak.
A big reason struggling companies do not turn around is their inability to properly handle opportunities to do so. Let's look at three red flags facing Kodak, and why investors should stay well away from the stock.
Image Source: Getty Images.
1. Allegations of misconduct
Currently, both the U.S. House of Representatives and the Securities Exchange Commission are investigating Kodak's board members for allegedly issuing millions in stock options and making insider trades days before news of the company's $765 million loan consideration was made public. In September, a law firm hired by Kodak found the company did nothing wrong after an internal review, but that creates more pieces for the puzzle regarding a potential conflict of interest. Since August, the once-promising pharmaceutical loan has been placed on hold. Given the severity of the allegations, there is no reason why the government agencies wouldn't pick another entity with better corporate oversight than Kodak to receive the loan.
2. A hypercompetitive market
Even if Kodak magically gets its funding back, there is little reason to expect the company can profit from making ingredients for generic drugs. First of all, one of the drugs on the company's manufacturing list has repeatedly shown no benefit when given to patients in clinical trials. Secondly, Kodak would be up against many other generic manufacturers in a hypercompetitive deflationary environment. Due to the Food and Drug Administration's initiative to accelerate the approval of generic drugs in recent years, their list prices have fallen by more than 37% since 2014.
Finally, keep in mind that Asian countries account for manufacturing about two-thirds of all generic drug ingredients in the world due to the cheaper cost of labor and materials. While a potential loan award for making such generic APIs in the U.S. would undoubtedly bring back American jobs, it's difficult to see how such an initiative can be sustainable in the long term. It entirely misses the issue of lower production costs abroad, and that outsourced generic APIs still outcompete U.S. manufactured ones.
3. Poor financials
In the second quarter of 2020, Kodak's revenue and operating income before non-cash adjustments (EBITDA) decreased by $93 million and $6 million, respectively, to $211 million and negative $7 million. The company's digital cameras and photo printers are becoming increasingly archaic due to everlasting pressure from smartphones and cloud storage. Kodak is not profitable and has little cash left over after one accounts for its $113 million long-term debt and $51 million in annual operating lease liabilities.
From my vantage point, the entire pharmaceutical loan fiasco is nothing more than a trading rebound for a company with a declining long-term trend. Due to a long decade of missed turnaround opportunities, Kodak now has an accumulated deficit of $195 million since its inception, compared to a retained profit amount of $6.717 billion back in 2005. If investors are interested in pharma stocks, they should place their capital in a company whose management looks out for shareholders' best interests, and avoid Kodak altogether.
