What’s in Tuesday’s update?

Novacyt issued an update on its dispute with the DHSC regarding a supply contract. On April 9 2021, it announced it was in dispute with the DHSC over a contract for Covid-19 diagnostic kits and other products. The contract had been announced in September 2020.

The firm said that on April 25 2022, it was notified that the DHSC has now issued a claim against Primerdesign Ltd and Novacyt for £134.6m. Novacyt added the claim figure is broadly in line with the disputed Q4 2020 revenue.

It said it believes it has strong grounds to defend the claim and assert its contractual rights. The company also contends that it’s in a strong position to recover outstanding sums due from the DHSC. 

The firm added that it’s unable to provide further comment at this time due to the ongoing nature of this claim. Further updates would be provided when appropriate.

Is Novacyt a good buy?

Full-year results are due on 28 April, but 2021 performance is expected to be some distance below 2020’s. In a full-year update, the company suggested 2021 underlying revenue would be £95.8m. This figure excludes £40.8m in revenue from a contract cancelled by the DHSC.

Novacyt’s growth has been almost exclusively a result of the pandemic. In 2019, the firm recorded only £11.5m in revenue. In 2020, that figure jumped to £277m. So on that front, 2021 data doesn’t look like it’s going to be particularly good news. EBITDA is expected to come in around £36m. That’s in line with expectations but way down on the £176m recorded in 2020.

A key concern for me is that Novacyt is hugely dependent on one product area, and that’s Covid-19 testing kits. Covid products accounted for 95% of revenue in 2020 and 86% of revenue in 2021. That’s particularly concerning especially when the future of the virus is less than predictable. It might be the case that Covid-19 is here for the long run and that testing will remain an integral part of our daily lives. Equally, it could be the very opposite. After all, we don’t have daily or home testing for other viruses — well most of us don’t.

For me, buying Novacyt is too risky. I’m just not sure about long-term demand for Covid-19 testing. And the DHSC claim doesn’t make the stock look more attractive. I’ll keep an eye on this one but I won’t be buying any time soon.

The boom and bust is all down to the Covid-19 pandemic. Specifically, it’s about the success of Novacyt’s Covid testing kits. They were in huge demand through the pandemic, and that led to a massive growth share spike.

But Covid testing demand was always going to fall in the long term, and the rise of numerous (possibly cheaper) competitors was pretty much inevitable. So what we’re back to now, after the bubble has burst, is the real Novacyt and its long-term prospects.

Does the NCYT share price, now that it has fallen back to Earth, make it a buy? My ISA is lacking long-term growth stocks, and this might just be a candidate.

Full-year results

Investors are waiting for full-year results, due on 28 April, but we have some ideas of what to expect. In its full-year update, the company put 2021 underlying revenue at £95.8m. That excludes £40.8m revenue from the Department of Health and Social Care, which is under dispute after a contract cancellation.

Revenue in 2020 came in at £277m, so 2021 looks bad on that score. But the company recorded only £11.5m in 2019. That does still look like impressive two-year growth, and it could lend support to the NCYT share price.

EBITDA, before exceptionals, is expected to come in above £36m, for a margin in line with expectations. That is well below 2020’s £176m. But, again, we’re hopefully moving towards something sustainable over the long term.

Novacyt had cash of £102m at 31 December 2021, ahead of £91.8m a year previously. That alleviates any liquidity worries I might have had.

My main concern

There is one key thing that does concern me though. Covid products contributed 86% of Novacyt’s revenue in 2021. That’s down from a 95% figure in 2020. But it does reinforce the company’s dependence on a single product area.

The long-term prospects for the Novacyt share price do still appear to be tied firmly to Covid testing. I don’t want to tempt fate, but unless we start seeing more dangerous variants of the coronavirus, I fear that demand can only fall in the coming years.

Novacyt share price valuation

What about today’s NCYT share price valuation? If EPS falls by a similar proportion to EBITDA, we could be looking at a P/E of only around five. That looks super-cheap on the face of it. And there’s plenty of earnings downside built into a valuation like that — EPS could fall by a further two thirds and still leave a P/E of 15.

So what will I do? Will I buy, based on the possibility of a super low valuation once results are out? It’s tempting, with what I see as a decent safety margin in that valuation. But until I see how longer-term demand for Covid testing goes, I’m going to sit it out and just keep watching.

• The Novacyt share price soared from 20p in January 2020 to 1,194p in October 2020 as the firm rolled out testing kits for Covid-19
• The company is in a dispute with the Department of Health and Social Care over a contract cancellation
• Its cash position for 2021 is £101.8m, up from £91.8m a year previously

An Anglo-French biotechnology company, Novacyt (NCYT) specialises in clinical diagnostics. When the Covid-19 pandemic struck, the firm used its testing infrastructure to its advantage. It produced a number of lateral flow and PCR tests for use in many countries around the world. Over the past year, the Novacyt share price has fallen about 77% from its heights during the pandemic. I want to know if this price movement, and the underlying business, justifies investment in this company for the long term. Let’s take a closer look. 

Covid testing and the Novacyt share price

As the pandemic hit throughout the world, Novacyt worked hard to develop Covid tests. It was at an advantage given its speciality is clinical diagnostics. As the company ramped up its testing output, the share price climbed higher. At the end of January 2020, before the pandemic, shares were trading at 20p. As the crisis intensified, the share price topped out at 1,194p at the end of October 2020. The shares currently trade at 158.3p. 

In more recent times, the business has not been running as smoothly. It is still getting approval for its lateral flow and PCR tests, although it is unclear how much demand remains. From 1 April 2022, free mass testing will end in England. It is likely that other countries will follow, given the milder nature of the Omicron variant. I think this move away from free mass testing could negatively impact the Novacyt share price.   

The firm also has an ongoing dispute with the Department of Health and Social Care (DHSC). The dispute originates from a September 2020 deal to supply its Primerdesign testing kits for six months. The DHSC opted not to extend the contract and Novacyt says this has left it about £40m out of pocket.

Recent financial results

For the 2021 calendar year, company revenue stood at £95.8m. This was lower than the previous year’s total of £277.2m. It is worth noting, however, that this latter figure was 20 times greater than revenue in 2019. This is because of the income from the roll out of the testing kits.

Profits also declined from 2020 to 2021, falling from £176.1m to just £36m. This suggests that as the intensity of the pandemic subsides, the results and the Novacyt share price could steadily fall. It is worth noting, though, that the business had a cash position of £101.8m for 2021, up from £91.8m in 2020.

The Novacyt share price performed well during the pandemic. As conditions return to normal, however, much of its testing-related revenue will disappear. Non-Covid testing will remain, but I won’t be buying this company, owing to the downward trajectory of its results and share price. 

So, what exactly are investors upset about? And is this negative performance actually a buying opportunity for my portfolio? Let’s take a closer look.

A mixed bag of an R&D update

I’ve explored Novacyt before. But as a quick reminder, it’s a medical diagnostics company that specialises in pathogen testing kits. Needless to say, the pandemic created quite a favourable environment for it to thrive in. And in 2020, this stock was like a rocket ship after it became the first company to release a Covid-19 testing kit.

Unfortunately, this first-mover advantage didn’t last long. Other companies began developing their own cheaper kits. And this fierce competition likely contributed to the loss of the DHSC contract. Since then, Novacyt has been investing its capital in creating new products for the private sector.

The latest research & development update shed some light on the progress being made. And despite what the NCYT share price would indicate, there have been some encouraging advancements. Its Winterplex test for the 2021-22 flu season has been launched. And Escapeplex, for detecting four different variants of Covid-19, is also good to go. Meanwhile, the firm has co-developed a new tool called CO-Prep. This automates the process of liquid handling by lab technicians for its PROmate testing kit, reducing the risk of contamination and saving time.

However, as encouraging as this is, further disappointing news arrived surrounding its PathFLOW kits. Due to a backlog of regulatory approval applications and supply chain disruptions, Novacyt’s Covid-19 self-lateral flow tests have been delayed. And it could be another six months before they reach the market. Given that the pandemic is slowly coming to an end, the demand for these products is bound to fall. Consequently, they may no longer be as lucrative as initially anticipated. Therefore, seeing the NCYT share price fall on the news isn’t surprising to me.

Is the falling share price a buying opportunity?

The launch of its Winterplex and Escapeplex tests is an exciting achievement that should help recover some of the lost DHSC revenue. However, as a long-term investor, I’m not tempted by this business. Currently, the vast majority of its income originates from Covid-19-related products. Given that the pandemic is already starting to wind down, it’s unclear how this business intends to thrive in a post-Covid environment. Therefore, while the stock may be poised to surge in the coming months, I’m still keeping it on my watchlist.

However, since the beginning of 2020, the stock’s returned more than 2,150%, so long-term investors have been well-rewarded for holding the shares over the past two years. 

The question is, will the Novacyt share price keep falling, or can the company turn things around? 

Novacyt share price weakness 

Whenever I first come across a stock, I always try to understand the bull and bear arguments of the investment. As I’ve been covering Novacyt for the past two years, I’ve got to know the business reasonably well. 

At the beginning of 2020, shares in the company surged after Novacyt’s Primerdesign division received orders totalling €103m for its coronavirus test.

Thanks to this contract, revenue increased 900% year-on-year in the second quarter of 2020 to €36m. Then in April of this year, management announced revenues had risen further to €83m in the first quarter of 2021.

The company’s problems started earlier this year when it tried to extend a testing contract with the government. The agreement wasn’t extended even though it continued to supply testing equipment in line with demand from the Department of Health and Social Care (DHSC). 

The company is currently in a legal dispute with the Department of Health and Social Care. According to its latest trading update, it continues to work with its legal advisors. The parties still haven’t reached an agreement to extend the contract. 

Based on all of the above, it’s clear to me why the Novacyt share price has been under pressure recently. When any company loses its largest contract, the market can be spooked. 

What’s more, in theory, if an organisation’s sales and profits suddenly slump, the company will be worth less than it was. 

Slumping profits

Analysts are expecting a rapid drop-off in profitability over the next two years. The company earned £132m in 2020, but this is expected to fall to £60m in 2021, and £15m in 2022. This goes some way to explaining why the Novacyt share price has performed so poorly over the past few months. 

Of course, these are just projections at this stage. There’s no guarantee the company will hit these targets. It could earn significantly more, or significantly less. 

In the best-case scenario, the group will sort out its dispute with the DHSC, leading to a jump in sales and profitability. This could provide funding to support the firm’s expansion into other areas, establishing a more sustainable revenue stream. 

Still, despite this opportunity, I wouldn’t buy the stock for my portfolio today. As the organisation’s profits continue to slide, I think the Novacyt share price will follow suit.

It’s still nowhere close to where it was at the start of the year. But could the recent jump be an indicator that the firm’s woes are over? And should I be considering this business for my portfolio?

NCYT share price jumps on earnings

Last month, Novacyt published its six-month performance report. And at first glance, it was pretty impressive. The diagnostics specialist brought in £94.7m in revenue. That’s about 50% higher than in 2020, so I can see why the market reacted positively to the news. However, on closer inspection, this trading update may not be as fantastic as it seems.

I’ve previously explored what triggered the NCYT share price to crash in April. But as a quick reminder, the firm’s biggest source of income is a single contract with the Department of Health and Social Care (DHSC). Under this agreement, Novacyt supplies the NHS with Covid-19 testing kits. And it has proven to be a very lucrative deal, which was behind the stock’s surge last year.

Unfortunately, this contract was not extended as originally anticipated. And overnight, the vast majority of the firm’s revenue stream evaporated. Of the £94.7m reported as revenue this year, £40.8m originates from the DHSC and is currently in dispute. In other words, it remains unpaid.

It’s not all bad news

A more honest picture of the group’s performance can be seen by its non-DHSC income. This came in at around £53.9m, up around 20% versus last year. That’s still a good level of growth, and it seems it will continue throughout the rest of 2021. Why? Because Novacyt has managed to acquire several new contracts.

Firstly, its subsidiary, Primerdesign, has signed a new deal with the DHSC worth £4.7m, which runs until March 2022. The management team has also negotiated an extension with UNICEF to keep supplying Covid-19 tests until July 2022. Meanwhile, testing in the private sector continues to see high demand for Novacyt products, especially its latest generation of testing kits that can detect the key variants of Covid-19.

Consequently, management has posted a revenue forecast for the year of £100m, excluding income from its disputed DHSC contract. And compared to non-DHSC income last year, this is a notable increase. If the company can continue to grow moving forward, the NCYT share price could recover over the long term.

The bottom line

It’s encouraging to see the group’s revenue stream start to recover the recently-lost income. And, more importantly, diversify its revenue sources. However, one glaring issue I spotted in this latest update is the lack of information surrounding how the business will thrive in a post-pandemic world.

Currently, almost all sales are generated by Covid-related products. But the demand for these will naturally start declining as the pandemic comes to an end. Therefore, until management can answer how it plans to continue growing over the long term, I’ll be keeping this business on my watchlist.

Novacyt

First up is former penny stock Novacyt (LSE: NCYT). Based on analyst projections, shares in the clinical diagnostics specialist trade on just five times earnings. That seems ludicrously cheap considering this month’s half-year numbers.

Total revenue jumped 50% to £94.7m in the first six months of 2021 compared to the same period last year. A little under £54m of this came from overseas orders and the private UK testing market. The latter includes buyers operating in, for example, the film and travel industries.

Looking ahead, Novacyt thinks there could be more growth ahead thanks to fresh contracts, a new PROmate Covid-19 test launch, travel routes reopening and the colder weather arriving. While this all sounds great, there’s a chance that the last two of these won’t happen as quickly as the company would like. An ongoing dispute with the Department of Health and Social Care isn’t ideal either. 

Taking into account how volatile the shares have been over the last year, Novacyt is still only a cautious buy for me.

Serica Energy

Another ‘cheap’ AIM stock is Serica Energy (LSE: SQZ). The North Sea-focused oil and gas company’s shares trade on just five times earnings. That might prove a bargain in time.  In July, SQZ announced promising flow test results from its 50%-owned Columbus development well. The stabilised rate was “at the upper end” of what Serica expected. Once up and running, it’s believed the well will produce roughly 7,000 boe/d (barrel of oil equivalent per day).     As someone with only mixed success in this sector, I’m hesitant to buy shares in Serica. That said, I like that the company began 2021 with no debt and £90m in cash. The fact that the AIM stock is already producing from its Bruce, Keith and Rhum fields (previously owned by BP) is another positive. 

However, the risks involved in future drilling campaigns (such as the North Eigg project), not to mention the opportunities available elsewhere, can’t be overlooked. So, Serica would be another cautious buy for me.

Atalaya Mining

For an even lower valuation, I’d check out Atalaya Mining (LSE: ATYM). It’s trading at just four times forecast earnings. 

Atalaya produces copper concentrates and silver by-product at its 100% Proyecto Riotinto site in Spain. It also has an agreement to own up to 80% of Proyecto Touro, a brownfield copper project in the same country. And, based on recent numbers, this is another AIM stock that could prove to be a steal.

Benefiting from a strong copper price, EBITDA rose to just under €100m in the first half of 2021. Like Serica, Atalya also has a strong balance sheet with net cash of €37.8m at the end of June.

Of course, risks abound. Aside from setbacks that plague exploration, ATYM is never in complete control of its fate. Long-term demand for copper looks robust but commodity prices can be very hard to predict in the near term. That’s fine if I’m being paid to wait. However, there’s no dividend stream with Atalaya.

It goes on my watchlist for now. 

But then in April, the NCYT share price suddenly nosedived. And since then it’s continued to drift downwards.

Until Wednesday, that is, when we saw the shares climb 20% in just one day. Before I get too excited about that though, I need to put it into perspective. This latest increase puts Novacyt up 24% over the past 12 months. But at its earlier peaks, in October 2020 and again in January 2021, we were looking at gains of 300%.

Novacyt is a specialist in Covid-19 testing. We had been hoping for, and expecting, an effective vaccine since the very start of the pandemic. But it’s been clear for some time the virus will be with us for the long term, just like influenza. And testing demand will presumably continue with it.

The new Novacyt share price spike is down to a first-half update. Total revenue increased by 50% compared to the first half of 2020. Revenue from the firm’s contract with the UK’s Department of Health and Social Care (DHSC), which accounts for 43% of the total, jumped 121%.

Reasons for caution

That’s good, but I’m cautious over the comparatives with last year. They include a period when Novacyt was just getting started with its testing development, before sales had kicked off. My Motley Fool colleague Roland Head has raised a few concerns too, all of which I share. The most important issue, I think, is the reason for April’s price slump.

Novacyt had a contract with the DHSC for the provision of test kits, and expected it to be extended. It didn’t happen, and the announcement of the failure triggered the NCYT share price crash. In addition, there’s an ongoing legal dispute, and I fear that might prove expensive.

Further, it seems £40.8m of 2021 DHSC revenue is actually unpaid and still under dispute. That’s 43% of the first-half total. On the upside, the company still reckons it should achieve around £100m in non-DHSC revenue for the full year. But I really think I’d want to see how the dispute turns out before I’d consider buying.

NCYT share price valuation

On the upside, I can see demand for Covid testing continuing at high levels for the foreseeable future. And based solely on the mooted £100m revenue, Roland estimates a forward P/E multiple of only around seven. That, for a stock with growth potential, looks very attractive. And it does tempt me.

But I don’t know what the balance sheet looks like at the moment, and there are just too many uncertainties for me to invest right now. I generally tend to keep away from companies in legal disputes with their biggest customers too.

I’ll keep watching though, and hoping for future Novacyt share price dips.

Despite today’s gains, the Covid-19-testing specialist’s shares are down by 60% so far this year, due to concerns about future demand and a potentially expensive dispute with the NHS.

That slump means the shares are now up by just 15% from a year ago. But if the company can get back on track I think Novacyt shares could be cheap at the moment. Should I consider buying this stock ahead of a potential recovery?

Back on track?

Novacyt’s group revenue rose by 50% to £94.7m during the first half of the year, compared to the first half of 2020.

There’s good and bad news here. The good news is that non-DHSC (NHS) sales rose by 20% to £54m during H1. This growth is being driven by private demand for Covid-19 testing from companies testing their own staff. I suspect this growth is why Novacyt’s share price is rising today.

Looking ahead, management expect to report sales of around £100m for the full year, excluding NHS revenue. That would be a 64% fall from sales of £277m in 2020.

However, the dispute with the NHS is a serious concern, in my view. The company says £41m of 2021 revenue is under dispute and unpaid. In addition, around £24m of NHS invoices from 2020 are unpaid.

If the dispute goes against Novacyt, I think the company could face significant cash costs.

Missing information?

When companies issue trading updates, they usually put a positive spin on things. Sometimes, management excludes certain pieces of information. I think that may be the case with today’s update.

In my view, there are a couple of things missing. The first is that there’s no mention of any non-Covid products. Most of Novacyt’s previous updates have included some information on the company’s future plans.

The second piece of information I’d like to have seen is an update on the group’s cash position at the end of the half year. In June, the company said cash at the end of 2020 was £91.8m. That was eight months ago. I suspect that that balance has fallen sharply since then, but that’s only guesswork.

Novacyt share price: would I buy?

Based on management guidance for sales of £100m in 2021, my sums suggest that at a price of 337p, Novacyt shares could be trading on around seven times forecast earnings. I might normally be tempted at this level but, for me, there’s just too much uncertainty:

• We don’t know how quickly Covid-19 demand will fall.
• Novacyt’s dispute with the NHS could be expensive to resolve and result in a loss of future sales.
• It’s not yet clear to me whether Novacyt will successfully develop or acquire any non-Covid products.

To add to the uncertainty, long-time chief executive Graham Mullis is retiring later this year. He’ll be replaced by external hire David Allmond in October.

My feeling is that Novacyt is likely to face continued challenges over the next year. Unless things go very well, I expect further falls in revenue and profits — and the share price.

For this reason, I won’t be buying Novacyt today.

The stock has slumped as the outlook for the business has become increasingly uncertain. The company is involved in a legal dispute with the NHS that relates to 45% of last year’s sales. Novacyt also faces a tougher market outlook, with demand for Covid-19 testing falling.

A record-breaking year

Novacyt had an incredible year in 2020. The company generated a pre-tax profit of £132.4m on sales of £277.2m. This growth was driven by the company’s role as one of the main suppliers of Covid-19 PCR testing kits to the Department for Health and Social Care.

It was a profitable business — Novacyt’s operating profit margin hit 60% in 2020. The company was able to repay all of its debts and ended the year with net cash of £91.8m.

Unfortunately, this strong performance has been spoilt by a messy dispute with the NHS .

Bad news for shareholders

Investing in companies that are involved in legal disputes can be risky, as the eventual outcome is often unpredictable. I’m worried about the potential impact of the NHS on Novacyt shares.

The firm’s share price crashed in April when the company first revealed this problem. Details are scarce, but today’s results did include an update on this situation.

The 2020 revenue affected by the dispute is £129.1m. From what I can understand, the NHS is asking for a refund. However, Novacyt is hoping to be able to settle the case by replacing some products under warranty. The company reckons this might cost “a maximum of £19.8m.”

To make matters worse, this dispute is now affecting product sales in 2021. Novacyt says invoices for £49m of product delivered to the NHS this year remain unpaid.

I don’t like this situation at all. The only good thing I can see is that Novacyt’s £92m net cash balance gives the firm some breathing space. However, I suspect that much of this cash will be needed to resolve this legal claim.

Novacyt shares rely on growth hopes

However, I can see two reasons to be optimistic about the outlook for Novacyt shares. Firstly, I think the stock may still be cheap. The latest management guidance is for sales of £100m in 2021, excluding the disputed NHS sales. CEO Graham Mullis expects to be able to maintain a gross profit margin of 70% on these sales.

My sums suggest this values the stock at around 10 times 2021 forecast earnings. That seems reasonable to me.

The other reason for optimism is that Novacyt is continuing to develop new non-Covid products for the “respiratory, transplant and infection disease markets.” Success here could help to offset a continued decline in Covid-19 testing.

Would I buy Novacyt shares at under 400p today? Personally, no. The combination of legal risks and the firm’s dependency on Covid-19 testing makes it too risky for me. Although the shares could recover well, I think a gradual decline is more likely.