After developing a popular test for Covid-19, shares in Novacyt (LSE:NCYT) soared by 21,000%. The price then fell by a third from its peak. To find out whether the current price is justified, what Novacyt could be worth one day, and what happens when a cure is found, we spoke to Vadim Alexandre, healthcare analyst at SP Angel and one of Novacyt’s most trusted advisors.
Lee Wild, head of equity strategy at interactive investor:
The healthcare sector is incredibly active right now, what with the Coronavirus pandemic and its impact on the health of the world population. The biggest trend since February has been COVID-19 and the star of that expanding niche has been a company called Novacyt (LSE:NCYT).
Few would have even heard of the company this time last year, but now it’s grabbing all the headlines and is the best performing stock of 2020.
Now just to give a bit of background, the shares were trading at around 6p a year ago and they just exceeded £12, so that’s an eye-watering gain of 21,000% in just 12 months.
You’ve watched this happen from a front row seat because you’re one of the company’s advisors and joint broker. You work for the company, so that gives you a great insight into its business and future prospects. So look, I’ve got lots of questions for you, Vadim, but I think first of all it would be very useful if you could explain to viewers exactly what Novacyt does and why it is so special.
Vadim Alexandre, healthcare analyst at financial advisor and broker SP Angel:
Perfect. So Novacyt is a diagnostic test manufacturer, so they develop tests for all kinds of things, but one of the areas that they specialise in is infectious disease. And the reason Novacyt has done so well in the last year is because they were one of the first manufacturers of a test to test for SARS-CoV-2, which is the virus that is behind COVID-19.
So they started that test, they were developing that test early on when the pandemic was just beginning in China, and as a result, once, you know, as this pandemic started to spread, the virus started to spread outside of China, they already had a test up and running.
They got regular – one of the first to get regulatory approval for that test, and then I guess the rest is kind of history. They were the first to start selling the test, they were exporting the test, and in the UK they were one of the first to start supplying the government with the test.
It’s won quite a few contracts, so who’s it actually working for at the moment?
So more recently they had a big second contract actually with the Department of Health here in the UK, so they’re one of the primary suppliers to the NHS.
Now originally, back in April I think or even a bit earlier, March/April time, the NHS needed tests, right? We all know how desperate the world was for tests, particularly here in the UK, or the UK government needed to find tests, and the problem is that globally everyone was trying to find these tests at the same time.
So what that resulted in was a bit of a bottle-neck in reagents, so most nations had to go to domestic, you know, turn to domestic production.
So they were one of the first to produce these tests, so they signed an agreement with the Department of Health, it’s the DHSC is the acronym of the Department of Health. first to get tests into centralised labs. So the first test that were rolled out were, you know, you get a test, a swab done, and then you get it sent to a central lab and then it gets processed and you get an answer within 24 hours or a bit longer initially.
So that was the first contract they got with the Department of Health, and then more recently they had another contract, another bigger contract, which runs at the same time, it runs – you know, the centralised lab testing continues, but this one is to get a more localised test done. This is at the point – what’s known as the ‘point of need’. So what you have here is testing being done in hospitals, and that was a pretty big contract, it was a £250 million contract.
I think a lot of viewers will think ‘Well look, from 6p to over £12 per share is quite phenomenal, and they’ve won some big contracts and what have you, but why has the share price risen so far and so fast, and is it justified?
Well I think it is. Well, it’s a question of scale. Let me give you a bit of – a few parameters on revenues that I think support that kind of share price rise. So last year, until the year ending 2019, the company did about just over £10 million in revenue, I think €10 or €12 million in revenue.
This year, at the interim mark, they did about €72 million, and the most recent contract with the DHSC, with the Department of Health, which they struck just last month, and a lot of it is to be deployed still in 2020, is for £250 million.
So, you know, it gives you a bit of a flavour for what size of revenues we’re talking about. I mean, this has been a step change, it’s a revenue surge, an unprecedented revenue surge for the business.
I mean, they’re looking at – you know, the forecasts out there are revenues up to 300 million, nearing €300 million for this year.
So, you know, 75, call it ball park €72 million at the interim mark, up on 10 million last year for the full year, or whatever, 10-12 million in the last year. You’re looking at a – whatever that is, a 30 times surge in revenues this year. It’s a substantial surge in revenues.
And then these tests carry high margins. At the interims I think the margins were about 80-85%, so whatever that was, 82-83% margin, gross margin, so a lot of these revenue drop straight to the bottom line. So the company is seeing this incredible surge in revenues and profits, and that’s what’s justifying this leap forward.
I might say they’re not alone, as in other companies listed on the London Stock Exchange have seen a huge surge as well in their stock prices.
Not quite as justified in that they haven’t seen the revenues coming through yet because they’re still either developing the test or getting it approved or are in the early days of manufacturing it, their tests, their respective tests.
So I think Novacyt is kind of well placed because they were a first mover, because they’re delivering these tests, and because they’re already seeing the revenues come through on these tests.
The company’s now – well approaching 900 million, well over £800 million, so is there another catalyst that might trigger further increases? I mean, what could Novacyt eventually be worth?
The first catalyst was seeing the revenues come through from the first Department of Health contract, which is for centralised testing, that continues, that’s continuing at pace.
The second catalyst that drove the share I’d say up to about £10 was the second contract from the DHSC. Now that contract stipulates a potential second phase, so the first phase was £250 million for 300 machines and the subsequent pull through on these machines of tests, OK, and the machines are not where the lion’s share of the revenue is, it’s the actual razor blade, which is the test pull through. So they have a minimum purchase contract with the Department of Health, which gets you to that £250 million.
But the contract also stipulates a second phase, which is another 700 machines. Now these machines are going to be rolled out primarily to NHS hospitals.
There’s about 1,300 hospitals in the UK, so, you know, for if 300 first work and it all goes to plan you would imagine the triggering of the second contract, the second phase of the contract.
If that gets triggered then I can see these shares rallying substantially further because it will be, just by definition, a larger contract than the 300 machines, because, you know, whatever, you can prorate that, maybe not 100% prorated but you can prorate it at least as a doubling of the primary, of the first contract, because it’s more than twice as many machines.
And you mentioned machines, I guess this goes back to just clearing up what Novacyt does. So does it make the machines, does it just produce the tests, does it do both?
Yes. So let me get a little more granular on specifically how they do these tests. So it’s a well known technique, it’s a PCR, so what you do is your test goes onto a machine that amplifies the genomic sequence of the virus, and that amplification allows you to then identify, to then – it’s what identifies the virus, because, as you might imagine, you have very low sample, very small amounts of virus, viral genomic sequences in the actual original sample, so you need to amplify it via this technique, which is PCR, to get it to a level where you can identify it.
So that’s a well-established technology in molecular diagnostics, it’s what they’re doing in the central lab, so in these centralised labs, it’s the same technique.
Their test is all of the reagents that come in vials that you put on these machines, and then, if you have to, then you take the viral sample, you put it in these vials. The machine then runs the test and then tells you whether you have the virus or not.
What they’re doing more recently with the second contract, with the second DHSC contract, which is the Department of Health contract, is that they now have these PCR machines which they’re putting into hospitals now.
So instead of the hospitals having to send the tests to centralised labs to run these tests they can do them in place in a hospital. The machine is being brought out of the central lab, if you like, to the hospital location.
It’s what’s known as ‘at the point of need’, testing at the point of need, and, as you might imagine, it radically accelerates the turnaround time on the testing. So that’s what their machines are, they’re effectively PCR machines which run their own tests.
Is there any other company supplying the NHS, or what is the competition, is Novacyt facing competition from other suppliers?
So yes, there’s a lot of people moving into this, as you might imagine, a lot of other manufacturers that make tests, and a lot of new players and new technologies emerging in this space. But what I would say is, this brings I guess investors to think about one thing; so how long will the pandemic last, how long will these tests be needed? Well right now we’re still underserved, you know.
You remember initially in this, so if you think about it from domestic terms in the UK, we initially had a crunch during the first wave where there weren’t enough tests. We’ve all seen the headlines, it was a big problem for the government.
It then caught up by getting manufacturers such as Novacyt, being one of the primary manufacturers, to get these tests rolled out. And then, come September, there was a second crunch again, because kids were returning to schools, everybody started testing again, and, you know, it wasn’t that long ago, if you remember, people had to drive 5-10 miles to get a test.
So this is kind of part of that second phase of getting more tests out again. So it wasn’t very long after that that the Department of Health gave Novacyt this second big contract.
So as you can see, testing is still ramping up, we still lack testing capability, and Novacyt is filling that void, OK. So then the question becomes, you know, when does that point come where there’s – and there’s more suppliers coming into the picture, that we know, which was your question, but they’re still not filling the gap of the need for testing.
So demand is still increasing faster than supply, is where I’m going with this. Now the question becomes, when does the supply meet that demand, and when does the demand start to come off?
Now currently we’re in the phase where supply is still not meeting demand, and Novacyt is the primary player because they have a test that’s approved, that they’re rolling out and they’re rolling it out now at the point of need.
Other suppliers are catching up and we’ll wait and see what happens.
I would say that there’s one thing to keep in mind, is that new technologies that aren’t proven really in terms of mass production and then large scale deployment, I would be a little more suspicious of that because they may just not get to market on time. So that’s my main point in terms of competing technologies, competing suppliers.
Now I guess the big question for Novacyt and for companies like it, and for investors wondering whether to buy at the current share price or current shareholders tempted to sell some or all of what they have. What happens when the COVID vaccine begins to roll out? I mean, that could happen over the next few months, we just don’t know. Now does business dry up when a cure is found, or what happens next?
So, basically, the COVID vaccine, first of all there are many vaccines in the pipeline and there’s been many warnings about vaccines won’t be silver bullets, right. So that’s the first thing, so we know that we’d be very lucky if we had the first vaccine work perfectly well.
Alongside that, even when there is a vaccine that works, you still need to be testing, we’re going to be testing for a long time I think to come, and that’s for at least the foreseeable year, so at least well into ’21 we’re going to need to be doing testing probably at higher levels than we’re doing now, and the government’s still ramping up to do so, OK.
The second thing is that there is this complexity of the double burden of flu with COVID at the same time this winter, and in future winters as well, in that you may still need to be doing a test that distinguishes between the two viruses, and other respiratory viruses, by the way.
So I can’t help but think that we’re going to be – there’s going to be a new normal of baseline testing that emerges post this pandemic.
In fact, I mean, if you think about it, you know, it’s quite surprising we haven’t tested for other viruses, admittedly because they weren’t as lethal, but, you know, I think the whole world has changed in terms of perception around testing and most hospitals will probably be testing against a battery of viruses when someone comes in with flu-like or COVID-like symptoms.
And it’s important because you need to know which way to treat these patients, because the treatment pathway is different for flu as is it for COVID-19 or other viruses.
So I think testing is here to stay, maybe not at these peak levels. You know, we expect the testing will drop off, probably not any time soon, so for us it’s well into ’21, that could even be longer, but then it will drop down to a new baseline which is much higher than what we were before this pandemic.
So Novacyt is not a flash in the pan, you’re saying, and we’re going to be hearing about and reading a lot more about Novacyt in the months to come?
That’s what we expect, and so far it has proven to be the case, because people were thinking, that this was going to be a flash in the pan back in March, April, May, the crisis got worse in terms of testing.
We never quite resolve testing, and we saw that in September when people went back to school there was another pinch-point in testing, and yet we had by that point six months of preparation, when I say ‘we’ I mean governments, you know.
So no, I didn’t think then it was a flash in the pan and, you know, the stock prices rallied quite substantially even after the first wave. I think it came back down in June to some 300p or something like that, and look, it’s up four times since then today.
So do I think this is sustained? It will be sustained for at least a year at these levels, even with a vaccine, because we will need to continue testing to know whether these vaccines work in practice.
We may have vaccines that work in clinic, which is what we all want, but then, as they’re rolled out, first of all we all know the rollout isn’t going to take a day, it won’t even take a quarter, it will probably take somewhere up to half a year, if not more, and it’ll be phased, right, it’ll go to frontline workers first and it’ll go to the people that are most at risk.
By the time we all get vaccinated, you know, that will be well into 2021. In the meantime, we need to be testing that whole time at ever increasing capacity. So the testing demand, as I was saying earlier, is still going up and it’s still ahead of supply.
And are there opportunities overseas for Novacyt, big contracts with the NHS, but what about overseas, America, those sorts of places?
Absolutely. Definitely, and they are selling overseas, and I expect to see more of that. I think if there’s an area, two areas that are triggers for further rallies in the shares, are the triggering of that second phase of the second contract, the DHSC contract, that’s the 700 machines I was telling you about, so that’s one big trigger. And then the second one that can come, more out of left field because these contracts can land at any moment, is a foreign contract, you know, they’re making inroads into the US and to places like Brazil and elsewhere.
Meanwhile, they are selling internationally. So yes, over and above these huge contracts in the UK they have potential for big contracts internationally.
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