1 Small-Cap Biotech Stock Poised for a Breakout

Key Points

• aTyr Pharma's leading candidate is targeting a relatively large market with unmet needs.

• The biotech company is expected to release data from a phase 3 clinical trial soon.

• Though things look somewhat promising for the company, aTyr Pharma is a risky stock.

• 10 stocks we like better than aTyr Pharma ›

Some prominent biotech companies tend to capture the majority of investors' and analysts' attention compared to their industry peers. aTyr Pharma (NASDAQ: LIFE), a small-cap, clinical-stage biotech, doesn't belong to that group.

However, the drugmaker has performed well this year; its shares are up 40% year to date. What's more, aTyr Pharma could have even more upside in the (very) near future. Is the stock a good investment at this time? Let's find out.

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Approaching an inflection point

aTyr Pharma's shares have performed well this year, partly in anticipation of the release of data from an ongoing phase 3 study of its leading candidate, efzofitimod. The small-cap biotech company said it would announce results from this trial in mid-September, so that should be coming pretty soon.

But what makes efzofitimod so interesting? It's being developed as a medicine for pulmonary sarcoidosis, a rare lung disease caused by the formation of clumps of inflammatory cells in the lungs. Pulmonary sarcoidosis is often characterized by a dry cough, difficulty breathing, shortness of breath, and, in some severe cases, lung scarring.

While there are various standards of care for the disease, they come with either severe side effects or limited efficacy in treating it. In other words, efzofitimod could address a disease with massive unmet needs. The medicine's mechanism of action has shown promise in helping to reduce inflammation and manage the formation of these clumps of cells in the lungs.

If successful in its late-stage study, aTyr Pharma's leading candidate could become the standard of care in this area.

Image source: Getty Images.

What does the commercial opportunity in pulmonary sarcoidosis look like? aTyr Pharma estimates that there are more than a million patients worldwide with sarcoidosis (which includes, but isn't limited to, the pulmonary variety). Approximately 200,000 are in the U.S., 150,000 in the European Union or the U.K., and 20,000 in Japan. Furthermore, the biotech estimates that approximately 50% to 75% of these patients could benefit from efzofitimod.

Taking the low end of that and focusing on the U.S. market alone, that's a target market of 100,000. Considering that there are few safe and effective treatment options, efzofitimod should make significant headway into this patient population if it proves effective in its phase 3 study, even assuming it's approved in the U.S. alone. Based on these numbers, the medicine could easily exceed blockbuster status within five years or so. That's significant for a company with a market cap of just $539 million.

Hedge your bets

aTyr Pharma has a lot riding on its upcoming data readouts. The company ended the second quarter with $83.2 million in cash, equivalents, and restricted cash, and subsequently raised approximately $30.7 million. With almost $114 million in the bank, the biotech estimates it will be able to stay in business for about a year after it releases its much-anticipated phase 3 study results. That's not very long, but it's about enough time for the company to launch efzofitimod.

Of course, that won't be a problem if efzofitimod knocks it out of the park. If that happens, aTyr Pharma will take advantage of its rising share price to raise additional funds by issuing new shares, which will support the regulatory applications for its medicine, as well as its early commercial efforts. That's what small-cap, clinical-stage biotech companies do in these situations.

But what if aTyr Pharma's leading candidate fails? The shares will implode, and it could mean the end of the company. That won't necessarily be the case, of course. Efzofitimod is also being investigated in a phase 2 study for systemic sclerosis, a rare, chronic disease characterized by thickening of the skin tissue, among other symptoms. However, considering aTyr Pharma's low cash balance and the fact that it lacks a partner with deep pockets, a clinical failure in its most crucial target market right now would be challenging -- though not impossible -- to recover from.

On the other hand, waiting until after the company reports phase 3 results, and initiating a position if the data is good, would limit investors' upside potential. My view is that efzofitimod looks promising, given its strong phase 2 results and large target market, but aTyr Pharma's stock remains too risky until the medicine has confirmed its clinical efficacy in its ongoing late-stage study. aTyr Pharma may be poised for a breakout, but it might be best to wait until after that breakout to buy shares, at least for risk-averse investors.

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Prosper Junior Bakiny has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.