Updated: Mar 4
Illumina is the market leader in genomic sequencing solutions; it develops machines that are able to interpret and analyse genomes for plants, animals and living organisms. Its customers are mainly clinical research institutions and global pharmaceutical companies that use Illumina’s products to further their research. During the pandemic, Illumina’s assay machines were the first machines in Wuhan to be deployed to develop the virus genome. Illumina was also at the forefront of the race to a vaccine, with its machines being used by vaccine developers in coding their vaccines.
Coronavirus aside, the bulk of Illumina’s business comes from the sale of machines and consumables (the products that the machines require to facilitate sequencing). The latest quarter provided a swing back into growth, with research across the globe returning to pre-pandemic levels. Some recent highlights from the Q4 earnings call on the core business were:
New partnerships in genetics with pharmaceutical clients Bristol Meyers Squibb and Merck.
A Korean genomics project, with the commitment to sequence 1 million genomes by 2030.
The NHS announcement to roll out the Genomics England project with 165,000 tests in 2021 and 1 million by 2024.
The highest overall order bookings for Novaseq machines since their launch in 2017.
The future of healthcare is personalisation. By understanding the genetic makeup of each patient, including their disease profile, we can tailor medicines to the specificities of their condition or at a minimum help choose which medication will be best for each patient. This was impossible not all that long ago, but the developments of companies such as Illumina, which has now brought the cost of sequencing down to around $600, makes optimised healthcare now affordable. A big sign of this is the contract win in the NHS, a typically cost conscious health body. For the NHS to see the value in Illumina’s services, and more importantly a national roll out of a genomics scheme, is a real positive read across for other less financially constrained markets.
Recently in 2020, Illumina proceeded with an 8 billion dollar acquisition of Grail, an early stage cancer diagnostics company backed by Bill Gates and Jeff Bezos. Grail, which was actually created by Illumina and spun out of the business years ago, is developing technology that allows for cancer detection from a simple blood draw. This is revolutionary technology that will enable earlier diagnosis of many forms of cancer. The Pathfinder study, which will be pivotal in determining the validity of Grail’s technology, is due for results in Q1 2021, with the launch of the Galleri diagnostic system in Q2 should the results read positively.
Looking into Illumina’s financials, at a glance, you have a pretty solid underlying business. Revenue has risen by nearly 50% in the years 2016 through 2019. Net income margin, a sign of the company’s profitability, sits at an average of 23.8% for the five year period. Illumina is also focused on R&D, and rightly so to keep ahead of competition. It spends roughly 20% of annual revenues in this respect.
The situation in 2020 turned slightly sour however; with Covid-19 closing workplaces globally, many research labs were shut, which lead to lower bookings of machines in addition to lower levels of consumables needed for sequencing genomes. This poor operating environment seemed to come to a peak in Q2 2020, followed by a marginal improvement in Q3 and a very strong Q4, picking up the slack from the business performance earlier in the year. This strong Q4 was less of a surprise (as close Illumina followers will be aware) — Q4 is usually the strongest quarter for the Illumina sales cycle, due to the nature of clients spending patterns.
So, 2020 was a year marred by the pandemic, and likely shareholders and analysts will be focused on the outlook for 2021 and beyond for a signal to the prosperity of the Illumina stock. One amber flag to keep a watchful eye on would be the Selling, General and Administrative expenses in 2020. Many companies I have observed throughout the pandemic and other crises have cut SG&A expenses as much as possible to retain profitability in a lower revenue environment. Typically, Illumina has kept this cost under control as it scales its business —however, 2020 marked an incrementally higher level of SG&A compared to revenue. This could have been the right move to make, especially to build momentum as laboratories and research facilities start to re-open. However, it could also signal intensifying competition and a difficult operating environment, leading to lower future margins. Definitely a metric to keep an eye out for in following quarters.
The outlook provided by Illumina management on the earnings call was very bullish indeed. A prior guidance for Q1 2021 had revenue at single digit decline. This has now been replaced with guidance of a high, single-digit revenue increase from a strong Q4 2020. This is unusually strong, as Illumina usually prints its best quarter in Q4. So to top this Q4 result with a high, single-digit increase shows momentum is strong coming into the new financial year. Management expects a strong year in 2021 and has guided to a 17-20% revenue increase with net income per share of $5.10-$5.35. Also, management highlighted a commitment to return to normal profit margins, expecting net income margins to improve throughout 2021. Whilst only a small contributor to revenue currently, management highlighted that increasing presence of new coronavirus variants will lead to global implementation of viral surveillance systems — something that will continue to drive performance over the medium term. Even though management have significantly raised expectations for financial delivery in Q1 2021, they have left full year guidance unchanged, alluding to a high chance of beating expectations in 2021.
After a significant stock price gain today, Illumina trades on approximately 90-100x expected 2021 earnings, roughly 20x sales. This is a very high valuation, almost 4 times the average S&P500 company. However, Illumina could truly be at the forefront of a healthcare revolution in order to tailor therapies, understand diseases and improve the lives of millions globally. There aren’t many companies in the S&P500 with the same scope for growth and level of profitability. More to the point, valuations in global stock markets have risen rapidly for growth companies over the last five years. It is not unusual to see companies that have yet to make a profit trade at over 20x sales. Despite its ‘expensive’ valuation, if you were looking to add a company to your portfolio with significant growth potential, I think Illumina is a great stock to look at. As with any ‘expensive’ growth companies, there can be opportunities to pick them up at more reasonable valuations — keep an eye out for the Pathfinder results in Q1, as you may find a good entry point.
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For disclosure - TheTwentiesTrader owns shares in Illumina.