Illumina: Gene Sequencing Leader In The Golden Age Of Genetics

Summary

• Illumina is strategically positioning itself as a key player in high growth segments of the genomic revolution.
• Illumina's metrics show that it is another perennially high priced stock.
• Illumina's leading gene sequencing portfolio includes two important revenue drivers, its sequencing platforms and its arrays business.
• The pandemic has helped certain aspects of Illumina's business, but overall, its impact has been negative.

Illumina (NASDAQ:ILMN) is the market leader in gene sequencing, a critical technology in today's world. As such, it deserves consideration in every investment portfolio. In addition to its highly profitable existing sequencing business, it is ideally situated to assess and participate in developing genomic opportunities; this adds substantially to its potential value.

Over the past year, I have been periodically trading the stock in small increments with a goal of slowly building a position at a palatable price. In this article, I will share my investigations into the company. So far, the more I learn, the more I see Illumina as a uniquely attractive company, albeit highly priced at the moment. I look forward to any comments, pro or con, that can add to understanding of the company.

Illumina balances its approach to innovative technologies between enabling and participating

During his recent Cowen Health Care Conference presentation, CEO deSouza gave a fascinating answer to the moderator's rambling question about Illumina's role in emerging genomic related industries. He noted that we are now in a golden age for gene focused innovation; if one characterizes the 20th century as the century of technology and the bit, he sees the current century playing out as the century of biology and the genome.

He cites hot developing areas such as single cell genomics, MRD, and liquid biopsy. He points to Illumina's role in catalyzing developing companies, such as 10x Genomics (TXG), NanoString Technologies (NSTG), and Guardant Health (GH) with a goal of providing genetic readout for these seminal technologies.

He notes:

...our philosophy is going to be we want to be the readout technology for all these really hot spaces that are emerging, we want to capitalize them and create them because they drive lots of demand for sequencing.

This approach applies to a broad canvas of projects. It does not however constrain Illumina's ambitions. deSouza continues enthusiastically:

...for ... hundreds of segments, our philosophy is that we want to be the platform, we want to be the sequencing engine that drives all these different segments. We want to be the best partner for the players in those segments. We want to win that business. We want to catalyze them. And not only by being the best sequencer, but make sure for example, the other things they need. We have an accelerator for example, where we invite terrific entrepreneurs to help them start businesses in these areas. We have Illumina ventures. And so, we want to catalyze those spaces, but most of the time and most of those hundreds of segments, we want to be the platform.

In special cases where a technology meets certain prerequisites, Illumina takes a role beyond acting as a catalyst. Two cited examples are:

1. Illumina's 2013 acquisition of Verinata Health which put it in the forefront of the clinical side of noninvasive prenatal testing [NIPT] and
2. Illumina's pending acquisition of Grail.

In connection with its decisions, deSouza listed the following criteria it looks for when deciding to acquire a company as opposed to playing a mere catalytic role:

1. Its segment has to have significant scale, assuring significant growth potential;
2. the opportunity must be differentiated from traditional approaches and protected with a powerful patent portfolio;
3. it must be strategically important.

The NIPT business qualified in all of these insofar as:

...NIPT was going to be one of the first significant genomics clinical space, and it ended up being the fastest adopted diagnostic test in the U.S. So we knew it was going to be a big space for genomics applications. And there was lots of IP in the space. And so you could actually create a differentiated position in that space. And then strategically, it helped us because we knew the future of our business was going to be much more clinically oriented than it had ever been. So until 2013, our entire market was the [IEO] market, the research market.

In this regard, Illumina is no different from any other platform company. deSouza cites Apple (AAPL) and Amazon (AMZN) as examples stating:

It's not any different from other platform companies ... like ... an Amazon or an Apple, they'll have the platform, and then they have a few applications that they provide themselves. It makes you a better platform company too.

Illumina is trading at an exceptionally high valuation

Illumina's summary ratings show it as neutral across the board, from Seeking Alpha authors, Wall Street, and Quant. Its quant factor grades (from 3/3/21) shown below help to focus in this sea of neutrality:

It is solidly profitable across its three time slots; its growth metrics are solidly challenged; its value gets a failing grade in all three time frames. As a reminder, quant value refers to:

The underlying metrics for Illumina are all way out of skew with the health care sector by factors of several hundred percent. Indeed, it is out of skew with its own normal price. Its market cap sits at a bloated >$58 billion.

The F.A.S.T. Graphs screenshot below provides a neat visual of its price (the black line) compared to its "normal" calculated PE of 52.56 (the blue line).

So, is this a stock to forgo until it more fully recovers from its stratospheric valuation? For some, the answer will be a resounding "yes". For me, it is a challenge. As a retiree, I am in no hurry to load up on an overpriced stock. So, as I write on 3/3/21, I have traded out of the bulk of my position. I plan to ever so gradually rebuild it on market weakness.

Indeed, as I was writing the foregoing Illumina's price has had a 10% correction, trading at ~$445 on 3/1/21, it has dropped to close at $398.85 on 3/5/21. It still has far further to drop in order to approach the blue line on the chart above.

Despite its high share price, Illumina's position as the number one gene sequencing company makes it an attractive investment

Illumina has a rich albeit rather short history, expanding its technology with acquisitions and growing its revenues. Its first 10-K on the Edgar database is for fiscal year 2000. At the time, it described (p. 3) its lead technology as:

...a proprietary array technology that enables the large-scale analysis of genetic variation and function. Our BeadArray technology combines fiber optic bundles and microscopic beads in a simple proprietary manufacturing process to produce array cassettes that can perform many assays simultaneously. Our BeadArray technology provides a unique combination of high throughput, cost effectiveness, and flexibility.

It generated year 2000 revenues (p. 33) of ~$1.3 million against expenses of ~$24.5 million. Its 2006 acquisition of Solexa for $600 million saw it expanding its business from genotyping to genetic sequencing.

This Solexa transaction was a big deal for Illumina. Solexa was an outgrowth of pioneering genetic research at Cambridge University in the mid-1990s. As stated in its fiscal 2006 10-K (p. 3):

On January 26, 2007, we completed the acquisition of Solexa, Inc. (Solexa) for approximately 13.1 million shares of our common stock. Solexa develops and commercializes genetic analysis technologies used to perform a range of analyses, including whole genome resequencing, gene expression analysis and small RNA analysis. We believe our combined company is the only company with genome-scale technology for genotyping, gene expression and sequencing, the three cornerstones of modern genetic analysis.

After the Solexa transaction, Illumina's major product offerings expanded to include the following instruments in accordance with its fiscal 2010 10-K (p. 10):

In terms of revenue, instrument sales have a dual role, the revenue directly generated by the sale and the revenues from the consumables used by the instrument. For example, Illumina's 2010 product offerings above generated 36% of its $902 million total revenue (p. 81), while consumables (including reagents, flow cells, and BeadChips) generated 56% (p. 11) of total revenues.

Fast forward to its latest 10-K for fiscal 2021; Illumina has the following instrument offering:

Its 2020 revenue (p. 30) of $3.2 billion break down (p. 6) as follows:

Most of our product sales consist of instruments and consumables, which include reagents, flow cells, and microarrays, based on our proprietary technologies. We also perform various services for our customers. In 2020, 2019, and 2018, instrument sales represented 13%, 15%, and 17%, respectively, of total revenue; consumable sales represented 71%, 68%, and 65%, respectively, of total revenue; and services represented 16%, 17%, and 18%, respectively, of total revenue.

Illumina shareholders can look forward to the day when we bid pandemic shutdowns farewell

With its broad footprint in the genomics world aspects of Illumina's business have flourished. For example, its movement towards clinical applications has been fortuitous. During its Q4, 2020 earnings call, deSouza stated:

More than 43% of our sequencing consumable shipments in 2020 were to clinical customers, which includes testing for oncology, reproductive health, and genetic disease. Clinical testing proved durable during the pandemic with clinical consumables growing about 8% year-over-year to approximately $890 million in 2020.

And in the fourth quarter, clinical consumables growth accelerated to over 20% year-over-year. In clinical, I'll highlight first the tremendous progress made in market access and reimbursement. We believe recent landmark coverage decisions will drive greater adoption of next-generation sequencing to new levels over the next several years.

Not all of its segments have fared so well:

Turning to our Research and Applied segment, revenue of approximately $1.2 billion represented just under 57% of our sequencing consumable shipments and was lower by about 6% year-over-year as customers were impacted by the pandemic. Research accelerated in the second half, growing 20% compared to the first half as researchers returned to their labs.

From an overall standpoint, the pandemic has been broadly negative for Illumina as detailed in its fiscal 2021 10-K (p. 30):

The COVID-19 pandemic and international efforts to control its spread have significantly curtailed the movement of people, goods, and services worldwide, including in the regions in which we sell our products and services and conduct our business operations. As a result, we experienced a decline in our sales and results of operations during 2020 compared to 2019. We expect the COVID-19 pandemic to continue to impact our sales and results of operations in 2021, the size and duration of which is significantly uncertain.

...Revenue decreased 9% in 2020 to $3.2 billion compared to $3.5 billion in 2019 primarily due to decreased shipments of consumables and instruments to our customers impacted by the effects of the COVID-19 pandemic. We expect our revenue to grow in 2021 compared to 2020 and 2019, although the size and duration of the COVID-19 impact remains significantly uncertain.

Conclusion

In this article, I have provided an overview of Illumina's current business. I have not discussed its pending Grail acquisition other than in passing. There are already four recent Seeking Alpha articles discussing this transaction in great detail, one neutral, two bullish (here and here) and one very bullish.

The market punished Illumina's share price when the deal was bruited and then announced on 9/21/20, knocking it down from ~$350 where it had generally traded in the preceding months to a low of $261.25 on 9/22/20.

This turned out to be a wonderful buying opportunity. Its price quickly recovered and actually reached $555.77 per share on 2/12/21 after a successful Q4, 2020 earnings report.

My approach to Illumina is cautious against a strong bullish backdrop. I expect that it will eventually prove to be a top performing growth stock. It has built a foundation in genomics that provides it an inside track on key developing technologies.

Analyst’s Disclosure: I am/we are long ILMN. 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.

I may buy or sell shares in any stock mentioned in this article over the next 72 hours.