FDA's Plans To Phase Out Animal-Testing In Drug Development Triggers Sell-Off In This Stock

The outsourced clinical research services provider's shares tumbled after the U.S. drug regulator announced a new approach to drug testing

Key Takeaways:

• Joinn Labs' shares fell on heavy trading as investors worried about a shift in U.S. policy to gradually phase out animal testing for new drug development
• Immediate impact on the company should be relatively limited, since it only derives about 20% of its revenue from the U.S., with most of the rest coming from China

Much is written about all the benefits that AI will bring, including greatly boosting the efficiency of new drug discovery in the pharmaceutical sector. But far less is written about industries likely to become victims of AI's success, making their current business models obsolete.

In the pharma sector, one industry feeling such pressure is the one that supplies lab animals and related services for new drug testing. Joinn Laboratories (China) Co. Ltd. (6127.HK; 603127.SH) was feeling that pain late last week, after an announcement from the U.S. about a gradual phasing out of animal testing requirements sent its shares diving.

Joinn supplies lab mice, rabbits and monkeys and related drug testing services to clients mostly in China and the U.S., and is part of a larger group of drug outsourcing service providers known as clinical research organizations (CROs). Its Hong Kong-listed shares fell 13.4% on Friday, while its Shanghai-listed stock fell 10%, the daily allowable limit for China's A-share market. The stock rebounded somewhat on Monday, with the Hong Kong-listed shares up 4.5% in early trade.

Even before the selloff, Joinn's stock was a shadow of its former self, down more than 90% from headier times when it was part of a group of fast-growing CROs supplying services to drug makers in both the rapidly expanding China market and also globally. But the company acknowledged in its latest annual results last month that those heady growth days are probably over and the industry "is currently in a transition period from rapid development to high-quality development."

The latest move by the U.S. Food and Drug Administration (FDA) appears to show that Joinn is in very real danger of being sidelined by that transition, due in part to the growing use of AI and other more effective, and also more humane, ways of testing the efficacy of new drugs in pre-human development stages.

In a major policy shift, the FDA said last Thursday it was taking the "groundbreaking step" of promoting the replacement of animal testing in the development of monoclonal antibodies and other drugs. It said it would gradually phase out its animal-testing requirement and replace it with a range of other approaches, including AI-based computational models of toxicity and cell lines and organoid toxicity testing in a laboratory setting.

"The new approach is designed to improve drug safety and accelerate the evaluation process, while reducing animal experimentation, lowering R&D costs, and ultimately, drug prices," the FDA said. "This initiative marks a paradigm shift in drug evaluation and holds promise to accelerate cures and meaningful treatments for Americans while reducing animal use."

Joinn acknowledged that the FDA shift was the likely cause of its Friday share selloff, on trading volume that was more than 10 times higher than the daily average in Hong Kong. "The company believes that the scheme will be gradually implemented based on solid scientific data research, pushing the industry to accelerate the pace of alternative research," it said in a statement.

The company didn't mention whether it is working to develop its own substitute AI testing models. It only made very brief mention of AI in its latest annual results in April by saying it "will increase investment and continuously promote the optimization of work processes based on artificial intelligence to improve labor productivity and service quality."

Long-term decline?

While the new FDA policy will benefit drug makers with lower costs and higher efficiency, and will also benefit animals that are spared from being used in such tests, Joinn falls clearly into the category of companies likely to suffer long-term damage from the shift. The downturn could worsen considerably if China also starts to phase out animal testing, since China accounted for 78% of Joinn's revenue last year, with the U.S. making up most of the rest.

Even before the FDA announcement, Joinn's situation was hardly too encouraging. The company's revenue fell 15% last year to 2.02 billion yuan ($277 million) from 2.38 billion yuan in 2023, marking the first decline since its Hong Kong IPO in 2021. The company blamed the decline on falling prices for its products and services as it faced growing competition.

While revenue fell, the same wasn't true for the company's cost of that revenue, which rose 8% year-on-year. As a result, Joinn's gross profit tumbled nearly 50%, causing its gross margin to also plunge to just 25.0% last year from 41.2% in 2023. The company's net profit also plunged 81% to just 74 million yuan from 397 million yuan a year earlier.

While the situation doesn't look too positive, the analyst community expects the company's revenue to stabilize and return to growth this year, projecting the figure will rise 5.5% to 2.13 billion yuan, according to the average of five analysts polled by Yahoo Finance.

But that same analyst community is becoming notably bearish on Joinn. While four analysts rated the company a "strong buy" in the first three months of this year, only one was still giving it that rating in April, among the five analysts polled this month. And while all the analysts rated the company a "buy" or "strong buy" in the first three months of this year, one changed their rating to a "sell" in April.

Despite losing more than 90% of its value from its Hong Kong IPO price, Joinn currently trades at a forward price-to-earnings (P/E) ratio of 16, which is the same as domestic CRO peer WuXi Biologics (2269.HK) and is a bit higher than the 12 for global peer Iqvia Holdings (IQV.US). That seems to show investors haven't given up on Joinn just yet, probably due to its relatively limited exposure to the U.S.

But the U.S. is often a leader in the global drug development market, meaning the overall trend away from animal testing is all but inevitable. Accordingly, investors should watch closely to see what alternatives Joinn is developing for the day when its focus on animal testing services becomes obsolete.