Having witnessed the rapid cooling of Omicron-led demand in Covid-19 diagnostics, the Sars-CoV-2 assay market is looking increasingly unattractive. Here revisit Co-Diagnostics, Inc. (NASDAQ:CODX) a name that we are extremely familiar with having tracked the company across the entire span of the pandemic.
We were buyers of the stock in January FY21 as a speculative position built around our core holdings in med-tech. We've since exited the position with a small loss, and believe impeding macro-headwinds remain for the company. With Covid-assay demand still diminishing, supplier inventory levels are likely at historically low levels, and the question is if they will seek to restore/repurchase inventory levels back to FY21 highs. The bulk of CODX's turnover is derived from Covid-19, so this is key to the investment debate for CODX looking ahead.
Here we reiterate a hold rating on CODX with a $3.24 price target. With Covid-19 test revenue diminishing substantially in Q2 FY22 [whilst rival test makers revenue surged YoY] there is low predictability of the company's future cash flows by estimation. Valuations are supportive of a neutral view and forward looking earnings are marred by the fact Covid-19 test volumes will likely dwindle as time goes on. Although it has other innovations in the pipeline, the timing and timeline for these are fluid for now and there's no concrete launch dates. We need further clarity on how CODX intends to distribute its top-line ex-Covid. Rate hold price target $3.24.
CODX came in with a fairly weak set of numbers when compared to Q2 FY21. It clipped revenue of just $5 million ("mm"), an 81.6% YoY decrease from $27.4mm the year prior. The substantial tightening at the top line came as demand for CODX's Logix Smart Covid-19 test, that was developed in response to the pandemic [more on this later]. CODX also recognized a 54% YoY decline in sales to third parties of ~$75,000.
Quarterly gross profit margin narrowed by 9 percentage points to 81.8% following the tighter revenue and unit volumes whilst fixed production costs made up a larger portion of revenues. Moving down the P&L, OPEX also narrowed by ~36% YoY to $8.3mm secondary to lower variable expenditures tied to sales volume. Quarterly operating loss came in at $4.17mm down from a profit of ~$11.8mm the year prior, again from the lower revenues and a $353,000 YoY gain in depreciation and amortization expense.
Meanwhile R&D investment for the quarter came in 16.7% lower to $3.9mm from a relatively high base in Q2 FY21, and the company also bought back $2.6mm of its own stock. It brought this down to a quarterly net loss of ~$2.7mm or -$0.08/share, down from a $9.7mm/ $0.34 per share after-tax profit last year. CODX did still see profitability from CFFO during the quarter. In fact, for the 6-months to Q2 FY22, it printed $9.4mm [$0.28/share] in cash from operations. However, also noted is that it added $2.9mm stock based compensation expense to this, whereas accounts receivable value jumped $8.56mm during this time.
Free cash flow ("FCF") has narrowed on a sequential basis for the company and came in at $1.15mm for the quarter and $25.2mm for the TTM. However, one point to note is that its TTM return on invested capital ("ROIC") has remained in the double digits at 24.2% last quarter and comfortably covers CODX's WACC hurdle of ~6.2% by ~4 turns. As seen in Exhibit 1, ROIC has remained consistently high whilst FCF is reinvested heavily back into the business.
Exhibit 1. Quarterly FCF continues to decline whilst TTM ROIC remains buoyant, albeit tightening as well.
This adds a bullish tilt to the risk/reward calculus and provides a solid bedrock for the company to continue seeing return on its investments looking ahead.
As have previously outlined, Covid-19 provided CODX with stellar revenue and earnings leverage that was reflected in its numbers at the time. Previously, we advocated that CODX's test volumes should remain high as there was currently no test to distinguish between influenza and Covid-19, a tailwind for assay kit producers. Management remain equally as optimistic, per language from CEO Dwight Egan on the Q2 earnings call:
This dramatic shift [decrease] in testing behavior was widely felt across the diagnostics industry. Experts believe other waves of COVID variants are all, but inevitable. However, the timing and severity are impossible to predict with every new variant, including the possibility of immune escape as variants and sub-variants by for dominance. In the U.S. alone, we are still seeing around a 100,000 new COVID cases reported per day, over 6,000 COVID-related hospital admissions and nearly 400 deaths, all evidence to date points to a resilient mutable virus with no indication it will go away and that we will be living with it for years to come."
Clearly, however, the Omicron-led demand for assay volumes has subsided and this is reflected in inventory values of both manufacturers and suppliers of the tests. We see evidence of this in CODX's numbers as its inventory value increased ~135% YoY in the second quarter to $4.7mm.
The question then becomes to what level will CODX's distributors replenish their already depleted inventory levels - depleted from low demand, and haven't been restocked in the first place. We note that Abbot Laboratories (ABT) recognized $2.3 billion in second quarter Covid-19 test revenue, underpinned by a $1 billion US Government contract. By our estimation, the enormous YoY gain in testing revenue from ABT says that it stole large market share in this domain from competitors such as CODX. Looking ahead, this weakens the investment debate substantially.
As the volume of aggregate Covid-19 testing continues to diminish, CODX's forward earnings outlook also weakens. Our research team has projected revenues of $44mm for FY22, sliding back to $39mm at the top line by FY23. This is estimated to produce $0.17 and $0.18 in EPS respectively.
Shares are also trading at a respectable 2.5x TTM earnings and are priced at ~18x our estimated P/E, and are priced at 0.7x book value. At 18x our FY23 EPS estimates of $0.18, this prices the stock at $3.24, a marginal degree of upside. Therefore shares are trading at a discount to book value but offer little to no upside capture from forward earnings, by estimation.
With these and the above mentioned points front of mind, we rate CODX a hold and await further clarity on the distribution of its revenue sources ex-Covid. We rate it a hold on a $3.24 price target.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.