Is Eastman Kodak stock a buy?

July 29, Eastman Kodak (KODK -4.51% ) announced that it received a $765 million loan from the U.S. government under the Defense Production Act to manufacture active pharmaceutical ingredients in generic drugs as part of a broader response to the coronavirus pandemic. After the news broke, investors went into a euphoric buying frenzy. In the space of a single day, Kodak’s stock jumped almost 300% and trading in the stock was temporarily halted for some time. Perhaps bizarrely, Kodak shares are now among the best performers of any stock industry, returning a mouth-watering 614% year-to-date.

Given the smashing jump in stocks, investors who didn’t buy the rally may feel like they missed out, and those who did may find it extremely difficult to hold onto their profits. Let’s see if the stock has already reached its full potential or if further growth could be ahead.

Image source: Getty Images.

The timing couldn’t be better

With the widespread adoption of digital cameras for smartphones, Kodak’s basic photo and film processing business model has become largely redundant. At its peak in 2005, the company generated approximately $11.4 billion in revenue each year. Fast forward 14 years and Kodak’s revenue had fallen to just $1.24 billion in 2019.

In addition, the company is struggling to make a profit. In the first quarter of 2020, the company recorded a pretax loss of $53 million on its $267 million in revenue. Many factors, such as the high cost of goods sold and employee pension commitments, significantly hamper its turnaround capabilities. Therefore, the company’s manufacturing contract could not have been awarded at a better time.

Does the company have a track record for this new venture?

Surprisingly, this is not the first time that Kodak has ventured into the pharmaceutical sector. In the 1990s, the company manufactured non-prescription drugs such as Bayerit’s aspirin. Ironically, in 1994 the company decided to spin off its pharmaceutical subsidiary Sterling Winthrop and focus instead on its core photo and film business (which we’ve already noted had fallen off a cliff). Part of Sterling Winthrop was sold to SmithKline Beecham (now GlaxoSmithKline) and grossed a staggering $2.93 billion. The rest, sold to Sanofiwas sold for $1.68 billion.

The company therefore has some experience in the pharmaceutical sector. Additionally, Kodak’s Film Chemical Manufacturing is a secondary skill that can be applied to Pharmaceutical Manufacturing. But it’s unclear how much it will cost to convert its existing facilities or open new facilities for this new venture.

Pharmaceutical technician in sanitized environment working on pill production at pharmacy factory.

Image source: Getty Images.

So what’s the verdict?

Initially, investors may be skeptical of Kodak’s ability to complete its new deal, due to the prevalence of generic drug giants such as Teva Pharmaceutical Industries and Mylanboth of which have a production capacity several sizes larger than Kodak’s.

However, under its contract, Kodak will produce pharmaceutical ingredients that are already facing shortages where reputable large-cap manufacturers cannot meet demand. Take the case of generic dexamethasone, a steroid that reduced the risk of death by 33% in patients with COVID-19 who are on ventilators. After the study was published, panic buying ensued. Although there are five manufacturers for the drug’s active ingredient, the United States Food and Drug Administration lists dexamethasone as currently in short supply.

What makes Kodak’s prospects even brighter is that the stock was already heavily undervalued before it received the Defense Production Act contract. At one point this year, Kodak had a market capitalization of just $80 million, compared to revenue of $1.24 billion. Even now, the company has a market cap of just $1.45 billion. The company’s financial health is also fair, with $263 million in debt versus $209 million in cash.

Therefore, I think this rally brings Kodak more or less closer to its fair value. Pharmaceutical investors who feel they are missing out may wish to open a small stake, while those who cannot resist the urge to take profits may consider selling some of their assets.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end advice service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.

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