Arcutis: Shares Plateau After Early 2024 Gains, But Further Upside Looks Likely (ARQT)

Investment Overview

At the end of January this year, I shared a note on Seeking Alpha covering Arcutis Biotherapeutics, Inc. (NASDAQ:ARQT). This is a Westlake Village, California-based biotech that markets and sells two dermatological products — ZORYVE® (roflumilast) cream 0.3%, and ZORYVE® (roflumilast) topical foam 0.3%.

Roflumilast is — according to Arcutis’ Q2 2024 quarterly report / 10Q submission:

a highly potent and selective phosphodiesterase-4 (“PDE4”) inhibitor. PDE4 is an established biological target in dermatology, with multiple PDE4 inhibitors approved by the FDA for the treatment of dermatological conditions.

Zoryve cream was approved to treat plaque psoriasis in July 2022, and also to treat psoriasis in children ages 6-11 in October 2023. The foam product was approved to treat seborrheic dermatitis in patients aged 9 years and above in December 2023. In July this year, the cream product secured its third major approval, for the treatment of atopic dermatitis (“AD”) in adults and children aged 6 years and above.

Arcutis completed its IPO in January 2020, raising ~$160m via the issuance of 9.375m shares priced at $17 per share. At the time of this note, the company’s traded share price is $8.3, meaning shares are down ~50% since IPO.

The situation was significantly worse at the time of my last note, however, with stock valued <$6 per share. My thesis was that slow sales of Zoryve products were weighing heavily on the company valuation — I noted that:

Across the first three quarters of 2023, net revenues from Zoryve amounted to $2.8m, $4.8m, and $8.1m, while Arcutis’ net losses amounted to $(80.1m), $(71m), and $(44.8m). Accumulated deficit as of Q3 2023 amounted to $(916m).

Doubtless readers would agree these figures make for tough reading, but I gave Arcutis stock a “Buy” rating in January, arguing that there were two ways of looking at the company’s commercial / financial predicament. Either the company was “running out of steam” and struggling to compete in lucrative, but crowded treatment markets, or that:

we could put Arcutis underperformance with regard to Zoryve revenues down to inexperience in the market place, slow uptake among physicians, and a smaller addressable market in the plaque psoriasis market.

Each of these problems could be solved in 2024, as management gains more insight into market dynamics – pricing has already emerged as a key differentiator between products – existing physicians continue to prescribe and persuade colleagues to prescribe – and the market opportunity converts into a multi-billion dollar one, thanks to additional approvals, in AD primarily.

Clearly, the latter thesis proved correct, as shares have risen in value by >40% since my note, but revisiting the thesis nearly 8 months on, does it remain valid?

In this post, I will answer this question by analyzing the company’s recent performance, and discussing the latest market dynamics, and try to provide some thoughts as to where I believe the share price may be heading next.

Let’s begin by looking at Q2 2024 earnings, released on August 14th.

Arcutis — Q2 2024 Earnings Review

In Q2 2024, Arcutis reported revenues of $30.9m — up an impressive 547% year-on-year. Zoryve foam earned $13.6m of revenues, and Zoryve cream $17.3m of revenues. Net losses also narrowed substantially, to $(52.3m) for the quarter, and $(87.4m) for the half year, versus a quarterly loss of $(82m) for the same period last year, and a half-yearly loss of $(143m).

At the end of January, Arcutis filed for a $300m mixed securities’ shelf, raising $150m at the end of February, at $9.5 per share. The company’s stock had been making strong gains throughout January and February, rising from <$3 per share to ~$12 per share during the period. It is perhaps buoyed by the foam approval and cream label expansions in December 2023, and positive analyst sentiment, triggered by better than expected adoption trends.

Arcutis reported $363m of cash as of the end of Q2 2024, versus $203.8m of long-term debt, which it was able to renegotiate terms on during Q2. The company’s new Chief Financial Officer, David Topper, who joined in April from Inmagene Bio, discussed the changes as follows during the Q2 earnings call:

The revised deal, which becomes effective at the start of October of this year, provides a number of very important improvements, including an extended maturity to 8/1/29, a decrease in the interest rate of 150 basis points, the flexibility to repay up to $100 million in the fourth quarter this year, together with the ability to redraw that money anytime through the first half of 2026, thereby saving us considerable interest expense. We’ve also deferred our 6.95% exit fee on the redrawn $100 million to the August 2029 maturity date and remove restrictions on asset purchases.

All in all, then, it was a solid quarter for Arcutis, with revenue rising, losses narrowing, new products performing strongly, and debt restructured to make it less onerous. The company was also able to announce a strategic collaboration and licensing agreement for roflumilast products with Japanese company Sato Pharmaceutical. According to a press release:

Under the terms of the agreement, Arcutis will receive an upfront payment of $25 million, and potentially an additional $40 million if certain regulatory and sales milestones are achieved. Arcutis is also eligible to receive tiered, low double-digit percentage royalties.

With all that said, since reaching a share price high of $12.5 in April, just before the mixed shelf announcement, Arcutis stock has retreated in value to $8.4 per share at the time of writing. This gives the company a market cap valuation of $983m, and there are some uncertainties for investors to consider.

No 2024 Guidance, Ongoing Losses, Rising Competition

Management has declined to provide any full-year 2024 guidance, and the business remains unprofitable — at the current rate of losses, cash could be close to exhausted by the end of next year, necessitating another dilutive fundraising. Addressing profitability on the Q2 earnings call, CFO topper told analysts:

I’m not going to comment on timing to profitability or breakeven, but what I will say, obviously, if you break SG&A into S on the one hand, and G&A on the other hand, selling obviously, is always going to be pretty closely correlated with revenue. So the way you get to break even in this kind of business, obviously is through economies of scale on the G&A items, right?

In short, the more product sales Arcutis makes, the faster it will move to profitability, which is encouraging, although the CFO also suggested the path to profitability will not necessarily be so linear:

Now, obviously, circumstances can change when you launch products like AD, for example, or launch a PCP program, you do incur some startup costs and things like that.

Analysts at Mizuho have previously suggested that Zoryve may achieve peak annual revenues of $1.8bn — $3.8bn by 2030, which, if true, makes a strong bull case for a company whose market cap valuation remains <$1bn.

Even with a relatively modest price to sales ratio of ~3x, if Arcutis were to meet Mizuho’s expectations, the company ought to be valued at >$6bn, provided it was also to achieve profitability before the end of the decade.

Zoryve is not the only topical cream available to patients in the indications of psoriasis and atopic dermatitis, however. Incyte Corporation’s (INCY) Opzelura, approved to treat AD, earned $338m of revenues last year, up 160% year-on-year. Roivant’s (ROIV) Vtama may have earned only $18.4m of revenues in fiscal Q1 2025, but the company has submitted a supplementary NDA (“sNDA”) to the FDA requesting approval in the larger AD indication, which is likely to be approved.

With competition intensifying in its core markets, not only from other topical creams, but also from the likes of Sanofi (SNY) and Regeneron’s (REGN) Dupixent – >$12bn revenues across a range of dermatological indications in 2023 — can Arcutis continue to grow Zoryve’s market share?

As we can see above, prescription growth for the more recently launched foam product has been impressive, and cream prescriptions also continue to grow, although there is some indication of growth plateauing somewhat.

Looking Ahead — New Products & New Approvals Encourage, But Share Price Buoyancy Hangs In Balance

One major reason for optimism that Arcutis stock can embark on another bull run is the approval in AD secured at the end of July. AD is a double-digit billion dollar market, and concurrent with the approval of Zoryve in this indication, Arcutis announced the signing of a co-promotion agreement with Kowa Pharmaceuticals America — according to a press release:

Kowa will leverage its primary care sales force to market and promote ZORYVE (roflumilast) cream and ZORYVE (roflumilast) foam to primary care practitioners and pediatricians for all FDA approved indications.

Arcutis will maintain responsibility for the marketing and sales of ZORYVE to dermatologists, other dermatology clinicians, and related specialists. This partnership is expected to expand the total addressable market for ZORYVE, providing access to a large portion of the 7.4 million patients treated outside of dermatology offices.

Arcutis CEO Frank Watanabe told analysts on the Q2 earnings call, in relation to the Kowa deal, that “we wouldn’t expect to see meaningful revenue contribution from those efforts until 2025.” However, with a new, more lucrative market now in play, and an experienced partner added, there ought to be optimism around the kind of revenue figures that can be achieved in 2025, even if management are reluctant to provide any guidance.

Meanwhile, Arcutis’ pipeline includes ARQ-255, a “deep-penetrating topical formulation of ivarmacitinib, a potent and highly selective topical Janus kinase type 1 (“JAK1”) inhibitor,” indicated for alopecia areata — a Phase 1b study is underway — while Arcutis 2022 acquisition of Ducentis BioTherapeutics gives the company access to candidate ARQ-234, “a fusion protein that is a potent and highly selective checkpoint agonist of the CD200 Receptor (CD200R)”, also targeting the AD market.

If we think about the performance of Incyte’s Opzelura in 2023 – >$300m revenues — my instinct is that Arcutis will believe it can match or exceed that figure within a couple of years. Therefore, adding in psoriasis and seborrheic dermatitis, a revenue figure of ~$500m may be achievable in 2026, I’d speculate.

For now, my suspicion is that Mizuho’s belief that Zoryve is a “blockbuster” (>$1bn revenues per annum) selling product in waiting, or even a >$3bn per annum selling product, is far too ambitious. However, a $500m selling product ought to be enough to keep growing the company valuation, provided costs and expenses do not spiral out of control.

The fact that there may soon be two other competing creams within the psoriasis and AD markets does not necessarily mean Zoryve’s market share will be impacted. We are at the beginning of these products’ commercial journeys, not the end, and having three separate companies pushing the non-steroidal, topical cream agenda may actually be an advantage rather than a hindrance.

As such, although Arcutis stock has been declining since its sensational bull run from ~$3 per share, to $12 per share in early 2023, my feeling is that Q3 and Q4 revenues figures will impress Wall Street. Provided we also see continued movement towards break-even, the company’s efforts will be rewarded with further share price gains.

I would set an upper limit market cap valuation of ~$1.5bn which could be achieved by mid-2025, so the growth story for Arcutis Biotherapeutics, Inc. stock is not explosive, in my view, but it remains tangible and achievable nonetheless.