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A key concern is that Novacyt’s legal dispute with the DHSC reduces its chances of becoming a strategic supplier in the long run
Thursday 15 Apr 2021 Author: Martin Gamble

A profit warning on 9 April from specialist clinical diagnostics firm Novacyt (NCYT:AIM) is a major turning point for how we view the stock. The investment case has materially changed which means investors should sell, even at a loss.

The investment case case was largely based on Novacyt becoming a strategic supplier of diagnostic services to the Department of Health and Social Care. This is now questionable given the parties are in legal dispute.

There are risks with dealing with government departments as highlighted by the apparent change of tactics in favour of lateral flow testing in the UK, despite their lower accuracy, which could provide a more challenging backdrop for polymerase chain reaction testing offered by Novacyt.

Furthermore, lower than expected revenues and cash flow means the revenue decline following peak Covid-related testing could be steeper than anticipated, which increases financial risks.

The source of the profit warning is related to a Covid-19 testing kit supply contract with the DHSC which was not extended into the second phase as hoped.

The initial term ran roughly to the middle of January 2021 and had a minimum contract value of £150 million. The second part of the contract was due to run for a further 10 weeks and was expected to generate a minimum £100 million of revenues. 

Novacyt said the failure to extend may have a material impact on fourth quarter 2020 revenues while 2021 revenues and profit may be lower than current market expectations.

The company said it had supplied its diagnostic testing kits in accordance with DHSC demand, and having taken legal advice, believes it has ‘strong grounds’ to assert its contractual rights.

A ‘material impact’ to Q4 2020 revenues raises the possibility of an exceptional charge against already reported 2020 revenues (€311.6 million).

Analyst Stefan Hamill at Numis hasn’t reflected this possibility in his new estimates, suggesting he sees it as a small probability, even though it is dependent on the outcome of legal proceedings.

Hamill has lowered his forecast for 2021 revenues by 44% to €179 million and his earnings per share forecast by 54% to €1.07.

The company reported first quarter 2021 revenues of €83 million, half of which came from the DHSC and the directors believe the kits supplied so far may be enough to satisfy DHSC’s 2021 full rollout plans.

At 440.8p, the shares are trading below the   632p level at which we said to buy on 8 October 2020. It is prudent to act when the facts no longer support the investment case and there are clear red flags, so sell.

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