Should you try to catch this falling knife after today's 35% slump?

Various pill packets

Shares in small-cap pharma stock Vernalis(LSE: VER) lost more than a third of their value in early deals this morning after the company published a mixed trading statement ahead of its AGM today. 

While management reported an 85% increase in the number of its Tuzistra XR, cough-cold medication prescriptions year-on-year, it noted that there needs to be "an acceleration in prescription growth" to meet the targeted 105,000 to 115,000 prescriptions for the year. 

With 70% of the 2017/18 cough-cold season remaining, this target is still achievable, but it looks as if the market believes the group will miss its own goal of increasing prescriptions by 200% year-on-year. 

Commenting on the firm's performance, CEO Ian Garland said: "Whilst we need to see acceleration in prescription growth to achieve our total prescription market guidance of a threefold increase in prescription volume, we are early in the cough-cold season and the US commercial team is executing a disciplined plan to accelerate growth over the coming months."

Rising losses 

The last time I covered Vernalis, I reported on the half-year profits for the six months to last December. For the period, a substantial loss of £11m was reported as marketing costs rose by nearly 30%. 

At the beginning of 2017, City analysts were expecting the company to report revenue of £16m for the year ending 30 June, before rising to £40m for the year after. As my Foolish colleague Ian Pierce reported in September, Vernalis managed to beat this revenue target, reporting sales of £21m for the year, but pre-tax losses ballooned from £15m to £21.6m. 

Vernalis' struggles have led City analysts to downgrade their forecasts for growth for the company as well. Analysts are now expecting revenues of just £15.2m for the year ending 30 June 2018 and a pre-tax loss of £36m. If the firm fails to meet its targeted distribution rate for the 2017/18 cough-cold season, then these forecasts will more than likely be downgraded further. 

Burning through cash 

Previously, Vernalis' one redeeming feature has been its cash balance. At the beginning of 2017, it had cash on the balance sheet of £74m. This balance had fallen to £61.3m by mid-year and according to today's update, is now £48.9m. 

With losses set to grow for fiscal 2018, I'm worried that it might find itself running out of money within the next two years. Of course, if the sales target for Tuzistra is met, the cash picture could be different by the beginning of next year. 

Still, it's clear that the firm is running out of headroom. 

The bottom line

Overall, I don't think it's wise to buy it after today's 35% decline.  The company's trading performance needs to improve dramatically over the next six months, and if it doesn't, management might have to ask shareholders for extra cash. 

It might be better to wait for concrete proof of success before buying into the growth story. 

Not suitable for all 

It looks to me as if investors should avoid Vernalis after today's decline. If you're looking for a company with a brighter outlook, I highly recommend the company profiled in this free report from the Motley Fool.

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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.