Burning Rock Localizes as Investors Grow Impatient

Key Takeaways:

• Burning Rock’s revenue grew 27% in the first quarter, but its costs grew even faster as it focused on building up new revenue sources
• Company’s older centralized testing services contracted in the quarter due to Covid disruptions, but its newer localized service with partner hospitals posted strong growth 

By Doug Young

Patience is an increasingly rare commodity among U.S. investors in Chinese companies these days. After giving cancer testing specialist Burning Rock Biotech Ltd. BNR the benefit of time to prove its business model, stock buyers seem to finally be running out of patience with the company, which reported its latest quarterly results last Tuesday.

Investors greeted the latest results with relative indifference, sending Burning Rock’s shares down by a modest 2.5% in the four trading days after the report came out. But the real story has been a 77% decline in the company’s stock since early April for no apparent reason. Many Chinese stocks notched similar declines in the second half of last year and reached a nadir in mid-March over a host of concerns, mostly related to growing regulation at home.

But most of those concerns don’t really affect Burning Rock, due to its position in the medical field. The company has been hit by Covid-19 restrictions that are wreaking havoc on many consumer-facing companies right now as China pursues its “zero Covid” policy. But otherwise, Burning Rock looks like it’s moving in the right direction.

The company provides cancer-testing services and related services through its own centrally run labs and increasingly through labs it is setting up within partner hospitals.

The central labs part of the business has struggled during the pandemic due to frequent travel restrictions that prevent people from visiting those central facilities during Covid-19 flare-ups. The latest such flare-up began in March and shut down the entire city of Shanghai for the months of April and May.

It’s not often that you hear company officials use the word “horrific” when talking about their business and the overall business climate. But the never-ending Covid frustrations now gripping China caused Burning Rock CFO Leo Li to resort to such language during the company’s latest earnings call. He noted that testing volume for the company rose 42% in the first quarter due to a strong January and February. But the growth rate slowed to just 17% in March when Shanghai first began to implement limited Covid-related restrictions, and slowed further still to 15% in April as the entire city was locked down.

“May was a horrific month with larger Covid impact compared to April and with grim sentiment,” Li said on the call. “And for us, we haven’t, for the month of May, we haven’t closed the month yet. But our estimate is that we’re likely to be down only single-digits in May.”

Despite what’s shaping up as a terrible second-quarter for just about all businesses in China, Burning Rock was also relatively upbeat about the whole year. It maintained its guidance for 620 million yuan ($90 million) in revenue for all of 2022, which would represent 22% growth from 2021. The fact that it continues to believe it can meet the target is relatively impressive, especially when one considers that many now think China’s economy could contract in the current quarter.

Decentralized testing

We’ll spend the second half of this space looking at the company’s latest earnings report, which really does seem to show it is sowing the seeds for strong future growth. As we’ve said previously, Burning Rock is transitioning from a business model that relies on centralized labs for cancer testing to one where it provides similar services locally through partner hospitals.

We’ve seen smartphone recycling specialist ATRenew RERE make a similar move recently, also with positive results. Such business localization tends to lower costs by reducing the need for national logistical capabilities. And it allows for fewer business disruptions in cases like Covid, where inter-city transport is often limited or even completely cut off.

Burning Rock’s overall revenue grew 27% in the first quarter year-on-year to 135.5 million yuan. That figure looks pretty good compared with the 12% growth in the fourth quarter and 18% growth for all of last year, especially when one considers that the latest Covid disruptions began in March.

That total covers up a huge divide between the company’s newer in-hospital and older centralized lab services. Revenue from the former rose 69% to 49 million yuan during the quarter. Following such strong growth, in-hospital testing services accounted for 36% of the company’s total revenue for the quarter, up from 27% a year earlier. By comparison, the company’s central lab testing services actually declined by 0.5% for the quarter year-on-year. That part of the business now accounts for 55% of the company’s total, down from 70% a year earlier.

The other growth story at Burning Rock is its pharmaceutical R&D services, which quadrupled year-on-year to 12.4 million yuan, making it look like another strong potential new revenue source.

The problem is that building up new businesses takes money, which was apparent in a 41% rise in the company’s operating expenses for the quarter – far higher than the revenue growth rate. What’s more, the company’s 350 million in quarterly operating expenses for the latest quarter was nearly three times its total revenue.

As a result, Burning Rock’s net loss rose sharply to 261.4 million yuan in the first quarter from 171.4 million yuan a year earlier. The “burning” element of the company’s name is certainly true when it comes to its use of cash. Over the past year it has burned through about a third of its cash, which stood at 1.3 billion yuan at the end of March versus 2.1 billion yuan a year earlier.

On the earnings call, CEO Han Yusheng estimated Burning Rock had enough cash to fund its operations for the next two years.

Anyone who believes the company will be able to ramp up its newer businesses and return to stronger growth over the next two years could find its stock is quite a bargain after the huge recent selloff. It currently trades at a price-to-book (P/B) ratio of just 1.2, not what you’d expect for a company with strong growth potential. By comparison, larger peers Roche (RO.SW) and Thermo Fisher Scientific TMO trade at P/B ratios of 12.6 and 5.3, respectively. And even the smaller Illumina ILMN trades at a far higher P/B of 3.5.