Omega Diagnostics (LSE: ODX) shares have surged in value over the past 12 months. Investors have rushed to buy the testing company’s stock as the business has moved to develop its own coronavirus tests. These efforts have paid off.
At the beginning of February, the company announced that it had inked an agreement with the Department of Health and Social Care to provide manufacturing capacity for Covid-19 lateral flow antigen tests. Today it emerged that this contract could be worth as much as £374m to the organisation.
However, this number is just a rough guide at this stage. As Omega warned in its press release, the figure “represents a maximum of the potential value of the contract“.
It also warned that the figure should not be used as an “estimate or forecast of the actual likely value of purchase orders to be received by the company“.
What’s more, at this time, the business has not received confirmation that its Covid-19 lateral flow antigen test “has passed the necessary performance evaluation“. Therefore, “there are no Covid-19 lateral flow antigen tests that can be manufactured by Omega, on behalf of the Government, at this time“.
While this order shows Omega’s potential, it has not guaranteed the organisation’s future.
Omega Diagnostics shares: challenges ahead
All of the above explains why Omega Diagnostics shares have hardly reacted to today’s news. This contract could be a massive deal for the firm. Unfortunately, as of yet, it does not have anything to sell.
Further, the contract only presents an opportunity to earn up to £374m. It does not guarantee it. As the UK’s vaccination programme starts to impact infection rates, I think the longer it takes for Omega’s Covid-19 lateral flow antigen test to receive approval, the less likely it is the government will need the entire order.
I believe that’s the most considerable risk facing the company right now. There’s a lot of expectation baked into the stock price after its recent performance. If Omega can’t sell its tests, I think the stock will quickly deflate.
On the other hand, if the test is approved and orders are placed up to the total value of the contract, Omega Diagnostics shares could be cheap at current levels.
Is the stock cheap?
The stock is currently trading with a market capitalisation of £183m. The healthcare industry is trading at an average price-to-sales (P/S) of around four today.
If Omega were to hit its entire contract quota in one year, that implies the stock could command a market value of just under £1.5bn. That’s the bull case here. However, everything would have to go right for that to happen, which, in my opinion, is unlikely.
I think the group’s chances of making over £300m of sales in one year are slim. With that being the case, I would not buy the stock today. After the recent blowout performance of Omega Diagnostics shares, I think the market is expecting far too much from the company.
