As I explained in my previous post, thanks to advances in genetic sequencing, we increasingly have the ability to spot disease years or even decades before symptoms present themselves. The World is witnessing the advent of personalised medicine which will completely transform the way we diagnose and treat disease. What has enabled this amazing breakthrough is genetic sequencing which is fast becoming very affordable and therefore available to everybody. The prospect of using our DNA to inform healthcare decisions is so significant that new players are flocking to this emerging industry all the time. Some are already making good on their potential. However, as in any nascent industry, not all stocks involved in genetic sequencing are likely to be winners. This is the reason I like to take a safer ‘picks and shovels’ approach to gaining exposure to this explosive trend. Today I’d like to tell you about gene sequencing machine specialist Illumina which I hold in my personal portfolio. Illumina’s dominant market share in sequencing machines is a huge competitive advantage. Their sequencing technology is applicable to a wide and growing range of genome sequencing applications so the beauty is we can be fairly agnostic about which application succeeds first in the market.
Illumina is the world’s leading manufacturer of DNA-sequencing equipment and the consumables for this equipment, which enable DNA to be sequenced in a timely, accurate, and affordable way. I view Illumina as a lower risk ‘picks and shovels’ play on the transformational trend towards personalised medicine. DNA sequencing is vital for early diagnosis and targeted treatment of many diseases.
Past performance is not an indication of future results.
Returns may increase or decrease as a result of currency fluctuations.
Illumina doesn’t make drugs, but it is a biotech company that specialises in manufacturing DNA sequencing equipment, developing and selling systems for large-scale analysis to understand genetic variation, especially as it relates to cancers and other diseases. The company is the world’s leading manufacturer of DNA-sequencing equipment and the consumables for this equipment, which enable DNA to be sequenced in a timely, accurate, and affordable way.
The first complete sequencing of a human genome - more than 3 billion base pairs of DNA - was finished in April 2003. Excitement over this achievement spurred the quest for cheaper, higher-throughput sequencing machines that could make the technology accessible for broader research. Solexa stepped in with the Genome Analyzer in 2006 and was acquired by Illumina the following year. The company’s innovation since that purchase has been the primary driver in reducing the cost of sequencing a human genome from $100 million in 2001 to less than $1,000 today. In fact, Ilumina promises its newest line of NovaSeq machines will bring down the cost further to a once unbelievable $100. These ongoing price reductions have expanded the market beyond a few well-funded labs to the broader research community. Estimates now show the sequencing market growing to $25.5 billion by 2025.
Before diving into more about Illumina specifically, it might be helpful to explain the different categories of companies operating in this field.
Gene-sequencing companies: These companies market systems to researchers that can be used to sequence genes using short- or long-read technology. They also sell consumables that are used each time a gene sequence is done. This is where Illumina’s traditional business sits.
Drug developers: These companies are using discoveries enabled by gene sequencing to overcome genetic mutations contributing to disease. Gene therapies developed by these biotechnology companies may seek to shut off (or knock down) the production of a gene, sidestep the mutation causing the genetic disease, or edit the gene to restore normal protein production.
Genetic screening companies: These companies provide genetic screening services to drug developers, doctors, and patients to inform drug development and treatment decisions.
The marketplace for gene-sequencing machines is dominated by Illumina and Thermo Fisher Scientific, both of which have built up a large installed base of short-read gene-sequencing machines at researchers worldwide. (Illumina also has a foothold in long-read sequencing through its 2018 acquisition of Pacific BioSciences of California).
Illumina is by far the bigger of the two in the market. Its most recent machines lowering sequencing costs further are opening up the door for a flood of research that was previously believed to be too expensive to justify. Globally, Illumina has over 17,000 systems installed, including the latest NovaSeq 6000 machines, based on an article from Seeking Alpha. Demand for NovaSeq has been robust, reaching $1 billion in shipments in just two years.
Thermo Fisher Scientific is no slouch, either. A far more diversified company, Thermo Fisher got into the gene-sequencing business with its $13.6 billion acquisition of Life Technologies in 2014, according to a Motley Fool article. Today, that business is reported within the company’s life sciences solutions segment. Thermo Fisher doesn’t break out exactly how much money its sequencers contribute to its top line, but its life sciences revenue increased 9% to $6.27 billion in 2018, accounting for 26% of the company’s $24.4 billion in total sales. The company launched its latest gene-sequencing system, the Ion GeneStudio S5 Series next-generation sequencing system, in 2018, and it’s a good bet that Thermo Fisher owns most of the remaining 25% market share not controlled by Illumina.
The outlook for demand for machines and consumables used by them appears very strong for gene sequencing companies. Illumina estimates less than 0.1% of species, 0.02% of humans, and 1% of human variants have been genetically sequenced so far. As gene-sequencing prices drop, drug developers can use it to create ever more personalised medicine, and people will be able to use it to gain a deeper understanding of themselves via their genetic profile. These machines are in demand from a wide range of customers including biotech companies, universities, and other genetic researchers.
I view Illumina as a lower risk picks and shovels play on the transformational trend towards personalised medicine. DNA sequencing is vital for early diagnosis and targeted treatment of many diseases. To spot genetic mutations, researchers must sequence, or screen, a person’s genetic material and then compare it to a baseline. Mapping human DNA in an accurate, timely, and affordable manner is difficult. Illumina has grabbed over 70% market share of the long-term $20 billion+ sequencing market due to its superior leading technology platform that is difficult to replicate, as well as the trust it has built with customers. In terms of competitive positioning, it really doesn’t get much better than this: sticky systems that customers are reluctant to replace. The ongoing interest in gene sequencing fuelled by lower prices and deeper insight into genetic disease has allowed Illumina to deliver 20 consecutive years of revenue growth and capture an estimated 75% market share.
Understandably high quality explosive growth companies like Illumina can rarely be bought on the cheap. But the market’s confusion about the recent Grail acquisition together with subdued new healthcare business levels during Covid disruptions means that we have the unusual opportunity to pick up the shares at a relatively lower valuation.
Warren Buffett and Charlie Munger have called them “moats.” Harvard Business School professor Michael Porter called them “barriers to entry” in his famous 1979 article “How Competitive Forces Shape Strategy”. As we have discussed before, factors that make it difficult for competitors to enter a market mean enormous power for any company that’s already there. Typically, with power comes profit. According to a Motley Fool source, Illumina has established one of the most powerful moats in recent memory. Shareowners who’ve held on to this dominant business have been rewarded with eye-popping results. Illumina has returned more than 4,300% since its 2000 IPO and almost 23% per year, compounded, since 2010. But investors should resist thinking all of the company’s gains are in the past. Businesses with a dominant position in a fast-growing industry are rare, and when they gain that advantage, they tend to maintain it for decades – to shareholders’ benefit. In my opinion, one of the best ways to profit from our continuing study and understanding of the human genome is to buy shares in Illumina and hold them for the long term.
I feel there is an attractive buying opportunity in Illumina given the market’s negative reaction to the company’s recent $8 billion acquisition of Grail, a company that was founded inside of Illumina and later spun out. Grail remains one of the most exciting early stage biotech companies out there. It has developed a unique blood test – or liquid biopsy – that can detect all kinds of cancers. And Grail is backed by some big names like Bill Gates, Jeff Bezos, and Google Ventures. So far studies show that Grail’s unique blood test accurately diagnoses more than 50 life threatening cancers at a very early stage so they can be treated earlier and with far less mortality. Illumina’s stock dropped significantly following the Grail announcement because it is a sizable acquisition that will bring down Illumina’s margins in the short-term. I view this as a buying opportunity because I do not believe Grail negatively impacts Illumina’s core sequencing business in any way. In fact, it adds a far larger market opportunity in a closely related field for Illumina. Grail has a real chance of becoming the leading early-stage cancer testing company and at this point in its development, it may be better positioned to realise this opportunity as part of Illumina.
I believe Illumina exercised sound judgment in both spinning Grail out four years ago and then moving to acquire the business today. While Grail will lower Illumina’s margins and return on equity meaningfully in the short-term, Illumina’s core sequencing business will continue to power ahead unaffected in earnings terms. I do not believe Grail would negatively impact the economics of Illumina’s core business even in a scenario where Grail fails to execute on the large opportunity in front of it. And, of course, if Grail can continue executing on its vision to become the leader in early-stage cancer testing, Illumina’s business and sequencing platform could become even larger and stronger.
I also feel investors were spooked that Ilumina paid $8 billion for Grail, that’s more than double Grail’s last known valuation (the early stage company was valued at $3.84 billion after its Series D venture capital round back in May). Undoubtedly this is a massive deal, and Illumina funded some of it by issuing new shares of stock, diluting existing shareholders. But to me, this pullback is a major buying opportunity as Illumina is playing the long game here in shareholder returns. Management explained the move by saying that it expected Next Generation Sequencing oncology testing, which can use liquid biopsies to analyse multiple short fragments of DNA for tumours, to grow from what is considered a less than $10 billion market now to $75 billion by 2035. It’s gargantuan! Compare this to Illumina’s annual revenues, which are under $4 billion per year right now. If Illumina can capture even just a small piece of the early cancer detection market, its revenues will easily more than double. It’s a tremendous opportunity. So this acquisition makes perfect sense in the big scheme of things.
And here’s where this story gets even more interesting…Grail spun out of Illumina back in 2015 to develop this technology around liquid biopsies. The company then raised $100 million in its Series A VC round in 2016, and Illumina was one of the investors. So we must ask – why did Illumina spin Grail out, help fund the company, and then buy it back for billions more five years later? The answer is simple. There is something to be said for letting a great team of innovators operate without the constraints of big corporate oversight. Plus, some of Illumina’s competitors were Grail’s early customers. That probably would not have happened if Grail had remained strictly under the control of Illumina. And those business relationships helped Grail grow and power its development. Had Illumina kept Grail in-house, it may not have had the freedom it needed to develop its tech behind closed doors and pursue the business relationships it needed to grow.
Past performance is not an indication of future results.
Returns may increase or decrease as a result of currency fluctuations.
At its recent quarterly update in February, Illumina revealed that the pandemic put a noticeable dent in yearly sales and profits, which is a bit ironic since rapidly sequencing the genome of the coronavirus has been the key to developing vaccines in such a short time! Through the first nine months of 2020, revenue was down 11%, as a lot of hospitals held off on buying sequencing equipment when their own revenues were weak. Illumina’s gross margins were down as well, but still pretty strong at 66.2%, according to a Motley Fool article.
But Illumina also revealed that its business has been registering strong rebound over the past few months, with the fourth quarter witnessing a faster-than-expected recovery for both its clinical and research customers. This business recovery is likely to have continued through recent weeks, thus pushing up the top line further. In particular, Illumina’s NovaSeq’s shipments have been robust over recent months on the back of the rebound in demand from customers who had delayed purchases due to the pandemic-led shelter-in-place policies. The company revealed sequencing instrument placements have also been robust due to continued strength in shipments of NextSeq platforms. Notably, revenues from China reflected strength in instrument placements. Furthermore, clinical sequencing consumables is gaining strength over the past few months on the back of strong rebound in both clinical and research customers. Barring any major new Covid lockdowns, these developments are expected to significantly contribute to the renewed growth of the top line for the year as a whole.
“In these unprecedented times, there are no borders, countries, mine, or yours. There’s only one focus: how do we stop COVID-19. As the world’s leader in next-generation sequencing, our technology helps power the heroes working around the clock to track transmission, conduct surveillance, develop therapies and vaccines, and protect our neighbours around the globe for years to come.”
At a recent JP Morgan Conference, Illumina also announced its latest innovation - Illumina Connected Analytics - for “transforming genomic data bottlenecks into catalysts”:
“This new and integrated bioinformatics solution provides a comprehensive, private, cloud-based data platform that empowers customers to manage, analyse, and explore large volumes of multi-genomic data in a secure, scalable, and flexible environment,” was how the company described this new offering."
It is clear that genetic sequencing is a market that will continue to grow for decades. As of 2016, less than 0.01% of the world’s population had been sequenced, and Illumina is creating a self-reinforcing moat in the form of the information gathered by its sequencers. In an industry preparing for decades of growth, such an early lead can be almost insurmountable.
More than 90% of the data generated from genome sequencing has been produced on an Illumina machine. The company offers a suite of software solutions to help researchers collect, store, and analyse the vast amounts of data required to achieve clinical breakthroughs. In the recent earnings call, management also announced the acquisition of BlueBee, a software company that “[enhances] the ability of users to gain insight from genomic data.”
And Illumina’s presentation at last January’s JP Morgan Healthcare Conference showed just how fast the company is building its lead. Since 2010, Illumina has increased its customer count tenfold and the amount of its data more than 50 times over. The dominance is clear in market share as well. Illumina’s $3.3 billion in 2018 sales was twice the amount achieved by its next nine largest competitors combined. These are the kinds of numbers that translate to pretty predictable earnings growth going forward.
As well as the post Covid rebound in machine and consumables sales, Illumina’s newest NextSeq machine range has been performing quite impressively over the past few months. Illumina’s mid-throughput portfolio’s product, NextSeq 2000, has also been witnessing favorable customer feedback and demand over the past few months. NextSeq 550 has also been maintaining its strength over the past few months.
The commercial availability of the P3 high-output flow cell, which further extends the reach of the NextSeq 2000 Sequencing System since November 2020, is expected to make significant contributions to the company’s revenues in the year ahead. The availability of NovaSeq 6000 v1.5 Reagent Kit since August 2020 to make whole genome sequencing more accessible and affordable for labs of all sizes is likely to continue boosting the company’s revenues as well.
Furthermore, the UK government announced a new human genome initiative aimed at uncovering genetic factors in susceptibility to COVID-19 in partnership with Illumina in a bid to understand the pandemic through genomics. Illumina is likely to gain further business from UK Biobank and other similar national organisations in the year ahead.
The genomics leader recently got a boost from identifying new COVID variants as part of its new collaboration with UK government body Uk Biobank. The identification of new and more dangerous COVID-19 variants in the U.K. through the use of genomic testing shone a light on the benefits of genomics and its underutilisation in the U.S. While the U.K. sequences about 10% of all COVID samples, which led the country to discover the more infectious strain, the U.S. had only sequenced about 0.3% of all COVID samples, according to a Wall Street Journal article. In response, President Biden advocated for more genomic surveillance of COVID strains in the U.S. in order to track outbreaks and new mutations, adding genomics funding to the proposed $1.9 trillion American Rescue Plan. The prospect of more hospitals and research institutions using genomics to track COVID variants would likely mean a boost in revenue for Illumina, the leader in the space.
In addition, Ilumina recently won a patent lawsuit. Although the genomics leader didn’t announce any financial details of the win, it was reassuring that the UK High Court ruled that BGI Genomics, a Hong Kong company, violated Illumina’s patents on gene sequencing chemistry. This ruling followed other similar wins for Illumina at patent courts in the U.S., Germany, Spain, Finland, and Sweden. Other patent lawsuits against BGI are ongoing in Hong Kong, France, Belgium, Denmark, Switzerland, Turkey, and Italy.
In my view, ILMN is an extremely solid lower risk high quality business in a fast growing market.
- Patent infringements
- Downturn in technology valuations
- Disruptive technological change
- Grail acquisition not approved
Considering the company’s revenue growth was disrupted by the pandemic, I see a strong opportunity for the stock to bounce back, particularly once COVID-19 vaccines are widely distributed. After a 31% drop in normalised EPS for the year to January 2021 from $6.4 to $4.43, profits for ILMN are expected to bounce back 37% to $6.11 in the year to January 2022. This may be conservative given the recent new lines of business we have seen developing.
It’s clear that the demand outlook for machines and consumables used by them is very strong in the years ahead given how much further we can utilise genetic sequencing. As gene-sequencing prices drop, drug developers can use it to create ever more personalized medicine, and people will be able to use it to gain a deeper understanding of themselves via their genetic profile. Gene sequencing is already contributing to the development of better, more targeted, and potentially safer medicines. Its use to inform treatment decisions, reduce the use of less effective treatments, and possibly reduce the risk of relapse or provide functional cures is revolutionary. In the future, we may see more blurring of the lines separating gene-sequencing system manufacturers like Illumina, drug developers like Novartis, and genetic services companies like Guardant. We’re already seeing collaborations that cut across these individual market segments, such as the acquisition of Grail. In typical fashion, Ilumina has been ahead of the curve on this.
It has been a great start to 2021 for Illumina, but we are still very likely in the early innings of genomics testing for a wide range of applications, including cancer, COVID and other viruses, and prenatal testing. Illumina’s results dipped in 2020, as researchers stayed home and hospitals didn’t do as much genetic testing other than for COVID, but they should rebound this year. There are numerous practical uses for gene sequencing, including research, drug development, biomarker analysis for treatment decisions, and determining ancestry and each of these will require the speed and affordability of leading edge genetic sequencing machines. The beauty is we can be agnostic about the relative success and speed of various applications by gaining exposure to the trend through Illumina’s ‘picks and shovels’ sequencing machines.
After considering the information above, and taking into account your own investment research, do you consider Illumina to be an investment with attractive prospects?
are there other genetic sequencing companies that you feel have excellent prospects?
This material is not investment research in accordance with the legal requirements designed to promote investment research independence and is also not subject to any prohibition on dealing ahead of the dissemination of investment research; and as such is considered to be a marketing communication.
All investments have the potential for profit and loss and your capital may be at risk. Past performance is not indicative of future results.