Novacyt (LSE: NCYT) stocks are up almost 10%, as of this writing. The Covid-19 testing specialist said its sales rose 230% to Â£ 277.2million in 2020. Novacyt’s share price has risen 60% in the past year, but the title remains nearly 70% below January’s high of 1,190 pence.
The stock collapsed as the company’s outlook became increasingly uncertain. The company is involved in a dispute with the NHS which involves 45% of last year’s sales. Novacyt also faces a more difficult market outlook, with demand for Covid-19 tests declining.
A record year
Novacyt had an amazing year in 2020. The company generated a pre-tax profit of Â£ 132.4million on sales of Â£ 277.2million. This growth has been driven by the company’s role as one of the leading suppliers of Covid-19 PCR test kits to the Ministry of Health and Social Affairs.
It was a profitable business – Novacyt’s operating profit margin reached 60% in 2020. The company was able to repay all of its debts and ended the year with a net cash position of Â£ 91.8million.
Unfortunately, this strong performance was marred by a messy dispute with the NHS.
Bad news for shareholders
Investing in businesses involved in legal disputes can be risky, as the end result is often unpredictable. I am concerned about the potential impact of the NHS on Novacyt actions.
The company’s stock price collapsed in April when the company first disclosed this issue. Details are scarce, but today’s results included an update on this situation.
2020 revenue affected by the litigation is Â£ 129.1 million. From what I can understand, the NHS is asking for a refund. However, Novacyt hopes to be able to settle the matter by replacing some products under warranty. The company estimates that it could cost “a maximum of Â£ 19.8million.”
To make matters worse, this dispute now affects product sales in 2021. Novacyt says invoices for Â£ 49million of products 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 Â£ 92million net cash balance gives the company some breathing space. However, I suspect that much of this money will be needed to resolve this legal claim.
The Novacyt share bets on the hopes of growth
However, I see two reasons for optimism about the outlook for Novacyt stocks. First, I think the stock can still be cheap. The latest management forecasts are for a turnover of Â£ 100 million in 2021, excluding disputed NHS sales. CEO Graham Mullis expects to be able to maintain a gross profit margin of 70% on these sales.
My sums suggest that this values ââthe stock at around 10 times the expected earnings for 2021. Sounds reasonable to me.
The other reason for optimism is that Novacyt will continue to develop new non-Covid products for the âRespiratory disease, transplant and infectious disease marketsâ. Success here could help offset a continued decline in Covid-19 testing.
Would I buy Novacyt shares for less than 400p today? Personally, no. The combination of legal risks and the company’s reliance on Covid-19 testing makes it too risky for me. While stocks may well recover, I think a gradual decline is more likely.
Roland’s head has no position in any of the stocks mentioned. The Motley Fool UK has no position in any of the stocks mentioned. The opinions expressed on the companies mentioned in this article are those of the author and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. At The Motley Fool, we believe that considering a wide range of ideas makes us better investors.