French pharmaceutical firm Novacyt SA (LSE: NCYT) is on a roll, thanks to surging demand for its Covid-19 testing products. Novacyt’s share price has risen by 170% over the last month and is up by a staggering 5,900% so far this year.
If Novacyt can use its Covid success as a launchpad for a broader product range, then I think the stock could still be worth buying at current levels. Today I’m going to explain what I’d do with Novacyt shares after this year’s gains.
Sales growth over 900%
Novacyt’s revenue rose by 902% to €72.4m during the first half of 2020. The group’s operating result was transformed from a loss of €660k in H1 2019 to a profit of €48.7m. That gives the business an operating profit margin of 66% for the first half of the year. That’s very high indeed.
Reassuringly, Novacyt’s profits were backed by strong cash generation. Understandably, the firm saw a significant increase in inventory costs and money owed by customers. But if we strip these costs out, operating cash flow for the half year was €45.3m. That’s almost an exact match for operating profit. Good stuff.
Novacyt soars on contract wins
The company is continuing to develop new Covid-19 testing products and recently launched a new antibody test.
New contracts are also continuing to roll in. Novacyt shares rose sharply recently last week on news of a UK government contract win with a minimum value of £150m over the first 14 weeks. Total revenue over the first six months could reach £250m. There’s also an option for a second phase which might be even larger.
It’s clear to me that Novacyt is profiting from being able to supply a market with strong demand and limited supply. I agree with the firm’s view that this strength is likely to continue into 2021, but I don’t expect this situation to last forever. History suggests that at some point demand will fall, or supply will improve. I suspect both.
The company says it hopes to use the commercial relationships it’s built during the pandemic to commercialise new products. The board also expects to expand Novacyt’s product portfolio through acquisitions.
Can Novacyt shares keep rising?
Novacyt repaid all its debt during the first half of this year, ending the period with a net cash position of €19.7m. That’s good. But in my view, investors who want to hold the stock long term now have to trust that management will be able to redeploy this cash into equally profitable new opportunities, post-Covid.
I admit that I don’t know much about Novacyt’s products and technology. But in my experience, small companies developing speculative new products often struggle to generate consistent growth.
It’s worth remembering that until the Covid-19 pandemic came along, Novacyt had reported a loss every year since 2014. During that time, the share count rose from 4m to 47m, as the firm continually tapped shareholders for extra cash.
Novacyt could receive a takeover offer and may well develop successful non-Covid products. But in my view, the easy money has already been made. Although Novacyt’s share price may continue to rise, I think it will come back down to earth at some point.
I’d be tempted to take some profits at this point.
