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Better Buy: Illumina, Inc. vs. Thermo Fisher Scientific

By Keith Speights - Dec 15, 2017 at 5:09AM

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Which stock wins in a head-to-head match-up between these two gene-sequencing leaders?

It's been a really good year for Thermo Fisher Scientific (TMO 0.92%). The medical and laboratory instrument maker's stock is up nearly 36% so far in 2017, nearly double the increase for the S&P 500 index. But it's been a really great year for Illumina (ILMN 3.62%). The gene-sequencing pioneer's launch of a new system has propelled the stock up almost 67% year to date.

Still, Thermo Fisher Scientific remains the much bigger company, with a market cap of close to $77 billion compared to Illumina's market cap of around $31 billion. Bigger isn't necessarily better, though. Which of these successful stocks is the smarter pick for long-term investors? Here's how Illumina and Thermo Fisher Scientific compare. 

Dart smashing through DNA strand to hit bulls-eye

Image source: Getty Images.

The case for Illumina

I think there are three major reasons why investors should like Illumina. At the top of the list is the company's technological leadership and innovation. Illumina's new NovaSeq gene-sequencing system is a prime example.

When NovaSeq was introduced in January, Illumina CEO called the launch "one of the most important inflection points of innovation in Illumina's history." NovaSeq certainly was the biggest story for Illumina in 2017, with higher demand than the company anticipated leading to terrific revenue and earnings growth. I expect the system will be the biggest story for Illumina for years to come as well. The company still has a large existing customer base using its HiSeq system, most of whom should convert to NovaSeq over the next few years.

NovaSeq is just the latest in a long line of innovations made by Illumina. The company paved the way for the $1,000 genome with its HiSeq X system, opening gene sequencing up to more customers. Illumina thinks that the technology platform on which NovaSeq is based could eventually lead to a $100 genome, expanding the market even more dramatically. 

Another key reason to like Illumina is its business model, which isn't too far off from the old "razor-and-blades" strategy. Illumina generates plenty of revenue by selling its gene-sequencing systems, but even more money is made over the long run from selling consumables for the systems. Last year, 64% of the company's total revenue stemmed from consumables. 

The third big positive for Illumina is its efforts to expand into new arenas. Illumina formed GRAIL in early 2016 to focus on development of a simple blood test to detect multiple types of cancer at early stages. While Illumina now owns less than 20% of GRAIL, it would still benefit tremendously if GRAIL is successful.

Then there's Helix. Illumina and several investment partners started the company in 2015 to develop consumer-oriented genomic products. It's still early for Helix, but Illumina thinks the company could become a major source of revenue in the future. 

The case for Thermo Fisher Scientific

What are the three top reasons for buying Thermo Fisher Scientific? I'd first tout the company's diversification.

Thermo Fisher has four business segments. Its life sciences solutions segment sells reagents, instruments, and consumables, including gene-sequencing systems that compete with Illumina. The company's analytical instruments segment provides instruments, consumables, software and services to biotechs, pharmaceutical companies, and other customers. Specialty diagnostics markets diagnostic test kits, reagents, culture media, instruments and related products. And the laboratory products and services segment provides exactly what its name says. 

The second reason for investors to like Thermo Fisher Scientific is its organic growth prospects. Thermo Fisher's core market should grow by 3% to 5% annually for a long time to come. The growth will be driven by increased wealth in emerging markets, higher demand for biologics and vaccines, and a heavier focus on precision medicine.

This precision medicine focus should be particularly beneficial to Thermo Fisher. China is ramping up its efforts in precision medicine. The company has a strong presence in the Chinese market, with the country generating around 10% of its total revenue. Between 2011 and 2016, Thermo Fisher saw 17% average organic growth in China. 

Organic growth is just part of the opportunity for Thermo Fisher. The third reason to like the stock is the company's ability to grow through acquisitions. Since 2010, Thermo Fisher has spent $29 billion on mergers and acquisitions. That total included at least 50 transactions, including the purchases of Affymetrix, FEI, Life Technologies, Patheon, and Phadia. 

I think there is still a lot of room for more acquisitions by Thermo Fisher. The life sciences and diagnostics industries remain fragmented. Even with its significant business development activity over the last few years, Thermo Fisher has been able to reduce its debt leverage ratio. The company doesn't have a huge cash stockpile. However, its free cash flow is substantial and continues to grow nicely, which should provide flexibility for more deals in the future. 

Better buy

If your main focus is on value, Thermo Fisher Scientific is the better pick for you. Its shares currently trade at 18 times expected earnings, compared to Illumina's forward earnings multiple of 48. 

However, if growth is more important for you, your best best is with Illumina. Continued momentum for NovaSeq should power the company to annual earnings growth of around 14% over the next few years, higher than the 12% earnings growth expected for Thermo Fisher.

My view is that Illumina is the better buy over the long run. Its sky-high valuation hasn't held the stock back in the past, and I don't think it will going forward. Over the next few years, NovaSeq will fuel growth for Illumina. This system won't be the last of the company's innovations, though. I expect Illumina will continue to bring genome costs down, expanding the market in the process. In my opinion, there will be plenty of great years to come for Illumina.

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Stocks Mentioned

Illumina, Inc. Stock Quote
Illumina, Inc.
$191.04 (3.62%) $6.68
Thermo Fisher Scientific Inc. Stock Quote
Thermo Fisher Scientific Inc.
$548.27 (0.92%) $4.99

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