Illumina's (ILMN 3.24%) second-quarter earnings crushed expectations last week. Investors cheered the company's raised guidance, and the stock is up more than 15% since the report.
Illumina's genomic sequencing machines read the As, Cs, Ts, and Gs of a human being's DNA and then digitizes them into a format that can be easily understood. One of the most exciting developments in the company's recent history was the introduction earlier this year of its newest NovaSeq model. NovaSeq has the potential to bring the cost of a human genome sequence down to $100, which would be a tenfold reduction from where we stand today.
This lower cost of sequencing has profound implications for the company and its investors, but also the entire medical community. Let's take a closer, DNA-level look at what this could really mean.
A new wave of customers
Customers are already responding well to NovaSeq's introduction. Management noted that the company shipped and installed 80 NovaSeq instruments during the quarter and still has a healthy backlog of 100 more on order.
Several of these orders are coming from Illumina's existing customers. Oncologist researchers and academic institutions are converting their high-throughput workflow over to the NovaSeq from the previous HiSeq models. This transition will cannibalize a decent portion of Illumina's existing sales.
But an interesting comment from CEO Francis deSouza was that more than one-third of NovaSeq's orders came from new or benchtop-only customers. This is important because it demonstrates that a new wave of customers is becoming interested in genomic sequencing. Several businesses couldn't previously afford the $1,000-plus cost of a DNA test. But they would be willing and able to pay $500, $300, or eventually $100 per test. The introduction of NovaSeq is expanding Illumina's total addressable market.
I expect we will see this additional capacity really come online in the direct-to-consumer market. 23andme and ancestry.com are helping the mass market become accepting of genomic testing, and they're using it to explain your family's heritage or point out health conditions you might be susceptible to. Consumers are becoming more comfortable with the concept, and the falling costs are enabling new opportunities.
DeSouza referred to this expanding consumer market as "the early signs of market elasticity." We'll keep an eye out for the lower price points to cause an increase in corresponding market demand.
A recurring revenue stream
That increasing market demand is great news for Illumina investors. The company obtains the majority of its sales and profits -- more than 60% of revenue and two-thirds of operating margin -- from selling the chemical reagents and consumable products that accompany each DNA test run on the machines. The highest-end HiSeq instruments can each go through $700,000 worth of consumables each year, and NovaSeq's utilization will be even higher.
These consumables create a high-margin recurring profit stream for the company and its investors. And if there's one thing Wall Street analysts love, it's predictable and recurring revenue streams. Watch for the placement of additional NovaSeq machines to cause analysts to raise their price targets higher in the coming months.
The Foolish takeaway
Illumina checks many of the boxes Foolish investors look for. It has a strong and unifying mission statement, "to unlock the power of the genome to transform healthcare and beyond." It has a highly motivated management team, and deSouza has plenty of experience in building platforms previously with both Symantec and IBM. It has innovation written into its DNA (pun intended), which makes it difficult for smaller competitors to catch up to its technological edge. And now it has a lucrative recurring revenue stream -- which will internally fund longer-term projects.
Genomic sequencing is no longer just for academic research or government-funded initiatives. It's going mainstream, which is introducing a new genomic era of entrepreneurs cracking the code to create new businesses. This is great news for shareholders, who can read the recent developments as a sign of long-term returns.