PMD: A Hairy Bet on Big Brother

We live in an Orwellian world; might as well try and profit from it.

For instance, say your boss asked you tomorrow for a lock of your hair, not for sentimental reasons but to find out whether if you’ve been dabbling in illicit drugs.

An inch and a half of a hair clipped from the back of your head can reveal your drug intake for the past three months, vs. as little as a few days from urinalysis. Slower-growing body hair could betray even more of your past.

Unless you are a union member covered by collective bargaining, failure to comply with this demand would likely get you fired and quite possibly professionally tarred as a suspected drug user.

But if you were a shareholder of Psychemedics (PMD), which bills itself as “the world’s largest provider of hair testing for drugs of abuse,” you’d at least benefit from companies’ growing insistence on knowing what workers ingest, smoke or inject on their own time.

Hair testing for drugs remains something of a cottage industry; Psychemedics  has a market capitalization of just $110 million. But the company says its thousands of clients in the U.S. and overseas include more than 50 Fortune 500 companies as well as Federal Reserve banks and major police departments.

Psychemedics uses a patented process to extract telltale drug traces from the hair stalk and identify them using an enzyme immunoassay. The results are then confirmed with mass spectrometry. The company claims its technology produces more accurate results than either urinalysis or the hair tests offered by rivals. These include the much larger Laboratory Corp of America (LH) and Quest Diagnostics (DGX).

The founder of Psychemedics, Austrian-born chemist Werner Baumgartner, pioneered hair testing for drug use. He garnered media attention in the 1980s by detecting heavy morphine levels in a lock of hair said to have been clipped from John Keats, the famous English poet.

The company got its own 15 minutes of fame in 1995, when it began promoting a mail-in test for consumers. It promised that a bit of hair discreetly snipped off a slumbering offspring would help parents discover said offspring’s drug use and pharmacological preferences. The stock quickly quadrupled before the high wore off.

Psychemedics would make some headlines again from time to time, but usually for uncool things like hiring public and school officials who’ve promoted mandatory hair testing of students, or contracting with a private school system that also employs the CEO’s brother as a principal.

The home test remains available, but it has offered no lasting uplift. Instead, the company remained heavily dependent on the corporate market and in particular on manufacturing employment, which as you may have heard has had its ups and (mostly) downs.

The stock remained a steady source of decent dividends and little else until last year, when Brazil began requiring drug hair tests for renewal of commercial driver licenses. The stock started 2016 near $10 and finished it at $25. Psychemedics revenue jumped 45% last year, while net income quadrupled thanks to the business boost from its Brazilian distributor.

Now, Brazil’s politicians are famously corrupt and getting more famous for that with every day. So one has to wonder how they came together to mandate hair testing for 13 million truck drivers every 30 months (once the renewal term is cut in half next year.)

It leaves me thinking that big Brazilian bounce Psychemedics got last year might not be bankable even if competitors don’t grab more of the business.

The market is clearly nervous about this as well. The stock got whacked 24% on Jan. 31 after Psychemedics’ independent Brazil distributor got hit with a court verdict accusing it of anti-competitive behavior. The verdict may yet prove immaterial as the company claims, but the Brazilian profit stream is crucial for safeguarding last year’s capital appreciation.

The augmented profit has made the equity look cheap at about 10 times cash flow. In the most recent quarter, the dividend currently yielding an annualized 3% consumed less than 20% of cash flow from operations.

If the Brazil business proves resilient, admittedly a big if, there’s upside here.

There’s also a U.S. catalyst on the horizon. The federal  Department of Transportation is currently waiting on the Department of Health and Human Sources to approve standards for hair testing. These standards would allow the DoT to let several large trucking companies test truckers’ hair for drugs instead of urinalysis rather than as a supplement to the urine testing, as currently.

And that, in turn, might encourage more competitors to make the switch as well.

This is as risky a bet as anything currently in the portfolio. My confidence in it is much lower than with the stocks I’ve recommended for fundamental reasons, much closer in fact to something super speculative live Tesla call options.

Also, please be aware that Psychemedics is microcap subject to violent moves and wealth-withering illiquidity. Do not invest capital you can’t afford to lose and don’t set stop loss levels, or you’ll be sure to lose it. With all these caveats, PMD is a buy below $22 for compulsive gamblers with drug-free hair only.


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