Investment Summary

Recent clinical trial momentum has begun to show on the Kezar Life Sciences, Inc. chart (NASDAQ: KZR). Following regulatory updates at the end of June, the title has been offered and holds our attention like a lifetime the sciences play to capture the alpha in the short and medium term. Here we have identified a potential upside pricing error and see a price target of $13 for KZR over the next 3 months. We believe the stock will continue to outperform its industry peers as investors reward its clinical trial momentum. We estimate the alpha opportunity will last until November, after the third quarter results. Looking forward to investors continuing to place idiosyncratic risk premiums like positive test readings in FY22, we price KZR at $13 PT long.

Exhibit 1. KZR price over 9 months

Market factors support further upside

We have seen a sharp decline in growth factors and equity beta this year as investors seek to improve quality. As such, low-beta, high-quality games are optimal for budgeting for equity risk in FY22. On that note, we see two key takeaways from the KZR investment debate. First, it has strengthened against the benchmark since June, having first been punished earlier this month following a setback in its PRESIDIO Phase 2 trial. Previously, it had been strengthening since November 2021.

Following their most recent updates, discussed later, KZR grabbed an offer and are now performing against SPX. But perhaps more importantly, its covariance structure has been moving downward since April and therefore seeks to provide investors with a source of uncorrelated alpha.

Investors pay a premium for idiosyncratic risk premia in FY22 and the fact that KZR is moving away from the broad market to the upside is proof that investors recognize it in the name, by estimation.

Chart 2. The downward covariance structure while strengthening relative to the benchmark is a bullish divergence factor

Further proof of this point can be seen in the table below. First, the medical devices and healthcare equipment sector also shrank in H2 FY22. As observed, KZR is strengthening against an already performing sector, a clear differentiator.

We also observe that it’s not just sector beta, as it has reduced correlation with the sector while gaining relative strength, as shown below. Therefore, we believe this proves that the market is rewarding the idiosyncratic KZR risk premia that are now on offer.

Exhibit 3. Further evidence of key differentials at work for KZR with investors outpacing name versus sector

Regulatory tailwinds

At the end of June, the company released a series of positive updates from its clinical trial of zetomipzomib. He first announced that the Phase 2 open-label MISSION trial, investigating the use of zetomipzomib as an investigational treatment for active lupus nephritis (“ALN”), showed a clinically meaningful response.

ALN is a sub-condition of systemic lupus erythematosus (“SLE”), an autoimmune disease that results in chronic inflammation of the body’s connective tissue. It is estimated that approximately 50% of patients with SLE are at risk of developing end-stage renal disease which often leads to death. Currently, the current standard of treatment is the chronic use of nonsteroidal anti-inflammatory drugs (“NSAIDs”), dialysis, or complete kidney transplantation (“FKE”). Zetomipzomib is reported herein as a selective immunoproteasome inhibitor identified based on optimization of ONX-0914. It shows a cytokine inhibition profile comparable to peripheral blood mononuclear cells (“PBMC”).

For the MISSION trial, the cohort of 21 patients received a 60 mg dose of the compound subcutaneously once weekly as combination therapy for 24 weeks. Of the group, 17 progressed throughout the trial, with 65% (11 of 17) achieving a ≥50% reduction in urine protein-creatinine ratio (“UPCR”) from baseline. Being a phase 2 trial, focusing on safety and efficacy, the treatment was well tolerated with only 2 patients experiencing serious adverse events. In addition, the results also showed that patients also experienced reductions in extra-renal manifestations of SLE.

One of the main benefits of the label is that it offers an alternative to NSAIDs, often the standard of care in the management of SLE. Long-term use of NSAIDs is linked to various medical conditions, including Cushing’s syndrome, peptic ulcers, acute kidney failure, and cardiovascular problems. Marcum and Hanlon (2010) showed that healthcare providers often run the risk of also over-prescribing NSAIDs. Therefore, zetomipzomib has the potential to compete with the standard of care as a standalone drug class operating in its own segment.

Sensitive price action

After significantly downgrading in the first half of FY22, price action has now turned bullish following this latest round of updates. In the days following the announcement, KZR stock price soared more than 100% as investors sought to price in the news. The rally has continued and based on the most recent price action, we see a cluster of price targets towards $21.70 as shown in Figure 4. Stocks are testing the first of several internal resistance lines, and if they break through those, it would be a bullish confirmation towards our price target.

Exhibit 4. Multiple upside targets to $21.70

On a daily 6-month cloud chart, stocks have moved back into the cloud and are now trading within cloud support. The shift line is now testing the cloud and we are waiting for this to break out to be fully convinced of the uptrend. Overall, volume has reached north and suggests that long-term volume continues to rise, while momentum remains high, as shown below.

Exhibit 5. Switch to cloud support

Retracing the lies from the March high to its May low, we see that the stock has already retraced around 38% of the move, where it is currently being tested. We are looking for a bounce from this level to the 50% tab on the fib, and that is at ~$11.40. Therefore, we expect our next technical target to be $11.40 from here.

Piece 6.

Evaluation

With its lack of profitability, assigning a concrete value to KZR is difficult. This is best done through a substantial DCF; however, given the changing rate regime and changing capital environment, the predictability of future cash flows is much less certain. However, KZR is trading at around 3 times its book value, below the GICS sector median, as shown below.

Exhibit 7. Multiples and comps

At about 3x book value, we would theoretically “pay” $15, in other words, we would overpay by about 58.5%. We therefore believe that KZR may currently be overvalued by this amount, and consequently priced at $5.98 coin, suggesting that long-term valuations may already be reflecting the regulatory tailwinds discussed in this report.

Piece 8.

Therefore, we have a number of price targets to consider. Mixing all entries on an equally weighted basis, we set a price target of $13.02, which suggests there is around 38% upside capture on supply.

We are therefore looking for a 38% return target at $13 per share with a rebalance or exit position at this point.

In short

We have identified a potential alpha opportunity in KZR following its recent tailwinds in clinical trials. We value the stock at $13 per share and are looking for a return target of around 38% at that level. We estimate the return period for this mispricing to be from July to November, around the time of the next results. Purchase rate.

Risks to the thesis include thesis drift, whereby positive factors can leave the debate. Investors may choose to favor more systematic risk instead and exit KZR positions to reduce equity risk. Additionally, negative news about the company’s upcoming lawsuits could weigh on the stock price. There are also inherent risks associated with investing in commercial-stage life science companies, and the potential for volatility is higher. These should all be considered carefully in the KZR investment debate.