James Faulkner on Omega Diagnostics – Diagnosis: buy

This week’s small cap has seen its shares stagnate for quite some time – until recently. Medical diagnostic firm Omega Diagnostics* (ODX) has two nascent opportunities to transform its financial performance and usher in a re-rating. Despite this, I believe the scale of these opportunities are not yet fully appreciated by the market, and the shares remain under the radar of many investors.

The first major opportunity for the group stems from the firm’s November 2010 acquisition of Allergopharma, a leading European allergy testing business. The acquired business specialises in the research, development and production of in-vitro allergy tests used by doctors to diagnose patients with allergies. Germany is currently the firm’s principal market, although the firm also sells into thirteen other markets, including Poland, Russia and Lebanon. A key attraction for Omega was Allergopharma’s bank of over 600 allergens – more than the current market leader. Clearly this would furnish Omega with a major advantage should it successfully launch its own allergy testing system to match the automated testing capabilities of competitors.

The main opportunity for Omega stems from the potential to improve the efficiency of confirmatory allergy testing through its commercial agreement with Immunodiagnostic Systems Holdings PLC (IDS) to gain exclusive global use, for performing allergy diagnostics, of the latter’s US FDA-approved IDS-iSYS platform, an automated ‘closed system’ analyser. The firm is currently working to produce a competitive working system for confirmatory allergy testing that will be able to process higher volume of tests and thereby increase reagent revenues for the enlarged group. Under the terms of the agreement with IDH, Omega will manufacture the assays and will OEM the instrument (rebadged with an Omega trademark – AllerSYS) from IDH who will also supply the cuvettes and other consumables.

Allergy screening…

Second, Omega will apply its existing Genarrayt microarrary test platform technology, which is currently utilised for food intolerance testing, to IgE (‘Immunoglobulin E’, or IgE, is a natural substance in your body that can indicate an allergic reaction). The firm believes that the Genarrayt microarray detection system has the ability to be used in a wide variety of applications where multiplexing (testing for a large number of analytes simultaneously on a single blood sample) can confer a competitive advantage, enabling the physician to commence the diagnostic process on a broad approach. Automation of slidehandling will allow more rapid processing of higher test volumes and thereby drive increased sales.

Although progress with calibrating its 40-panel allergy menu, to be launched on the IDS-iSYS instrument, was initially slow, the cumulative number of allergens through claim support (which examines stability and robustness of assays) has risen to eight, with a further 14 allergens having completed optimisation, five of which are part-way through claim support, and a further 11 allergens undergoing optimisation. Management believes that continued progress with its development programme is a cause for increased confidence in terms of commercialisation.

The IDS iSYS Immunoassay System, on which Omega intends to roll out its allergy tests.

AIDS testing…

The firm’s next major opportunity is the one that I’m most excited about. In 2012, Omega announced some positive developments regarding its infectious disease business, arising from collaborative work with the Burnet Institute in Melbourne, Australia, involving CD4 tests for AIDS which are a vital part of patient management (measurement of CD4 T-cells is required when determining when to commence antiretroviral treatment). Currently available CD4 tests require flow cytometry techniques which are lab-based, expensive and required cold-chain storage for reagents. However, this Burnet CD4 (latterly named Visitect CD4) point-of-care test does not require such infrastructure and therefore opens up the opportunity for widespread testing, particularly in rural areas of the developing world.

Considerable effort has been spent on pre-launch marketing activities including exhibitions and meetings with key opinion leaders in the Global Health community thereby “generating significant interest” which is “expected to translate into significant sales” in due course.

As with the IDS iSYS opportunity, the company is somewhat behind schedule with CD4, but management remains confident that Visitect remains a “game-changer” which is head and shoulders above the competition. Although several products are due to be launched before Visitect and others are in development, none can compete in terms of Visitect’s combination of price and ease of use. Visitect does not need an instrument (and therefore a power supply) and associated maintenance, it requires only a finger prick blood sample (not one drawn by syringe), and is competitively priced. It is therefore suitable for field use with minimal training. In Sub-Saharan Africa alone there are 15.5 million people who should be receiving antiretroviral therapy. Assuming each is tested twice a year, this represents a $155 million market opportunity for Omega Diagnostics.

The CD4 test was said to have taken the International AIDS Conference in Washington DC by storm, generating significant interest from the likes of the Clinton Health Access Initiative, Medecins Sans Frontieres and UNICEF. There has also been significant interest from China, where the number of people affected by HIV has been estimated at between 430,000 and 1.5 million. Given that the technology is unique in terms of its mobility, it is the perfect answer to the difficulties posed by the relatively underdeveloped health infrastructures of the developing world. Manufacturing capacity is already available in the UK and should be available in India and Brazil shortly.

The market opportunity for Visitect is huge. The global CD4 need is expected to grow substantially over the next 8 years as countries scale up their HIV/AIDS treatment programmes and this should see the number of tests rise from current levels of just over 30 million to nearly 60 million tests by 2020. The estimated cost per test for Visitect is £1.12 versus an estimated unit selling price of £3.21. With annual capacity at the Omega facility estimated at 2.5-7.5 million units, this implies sales potential of £8-24 million with gross margins of £5.2-15.7 million, thus underlining the scale of the opportunity.

Initial feedback from field evaluation studies for Visitect CD4 in Kenya and India are said to have progressed well, with over 60 patient samples having been run in India and a 200-patient sample evaluation having just been run in Kenya. The latter Kenyan study also included evaluation of the Visitect CD4 mHealth App Smartphone Reader, which adds an extra level of functionality to Visitect and further differentiates it from its competitors. Further tests are due to be undertaken, where the results for Visitect CD4 will be compared with standard flow cytometry results for the same patient samples. The success of these initial studies will lead to a roll-out of validation studies into other countries. Meanwhile, claim support studies have commenced in the UK to support the regulatory requirements in connection with CE-Marking the test, which is the standard EU hallmark for medical devices. Progress remains in line with management expectations and a further update will be provided in due course.

Valuation…

Shares in Omega Diagnostics currently trade at 27.375p, capitalising the firm at just under £30 million. For the current year to March 2014 house broker finnCap expects Omega to post adjusted pre-tax profits of £1.1 million, rising to £3.9 million for 2015, with the growth based on new income being generated from Visitect CD4 and the automated allergy testing.

The shares now trade on a prospective earnings multiple of 7.6x for FY15, which would surely prove overly conservative should the company come anywhere near meeting FY15 expectations. However, the main risk to the investment case remains the scale and timing of the uptake of Visitect CD4 among non-governmental organisations. Further such setbacks on the calibration of allergy tests for the IDS iSYS machine could also negatively impact forecasts. For me, the appeal lies in a relatively stable legacy diagnostics business with potentially high impact upside from two potentially transformational projects.

* The writer owns shares in Omega Diagnostics.