Shareholders of Illumina (NASDAQ:ILMN) have enjoyed a gain of almost 25% so far this year after a fantastic 71% rise in the stock price last year. The leading maker of gene sequencing instruments is capitalizing on surging demand for genetic information, driven by trends from precision medicine to consumer curiosity. But will the shares continue to produce outsized returns, or is the run about to peter out?
First-quarter results were well above Wall Street expectations, with revenue growing 31% to $782 million and non-GAAP earnings per share more than doubling from $0.64 in the period last year to $1.45. Non-GAAP gross margin improved from 66.4% to 69.8%, operating margin ballooned from 17.5% to 29.5%, and free cash flow grew 94% to $165 million.
The strong results led the company to raise its projection for full-year revenue growth two percentage points to a range of 15% to 16%, and to bump up guidance for non-GAAP EPS by $0.25 to a range of $4.75 to $4.85.
Those headline numbers would be enough to turn the head of any growth investor, but a dig into the details behind them shows that these growth rates may have some staying power. Instrument sales increased 18%, the third quarter in a row of double-digit growth, which hasn't happened since early 2015. But powering the results was accelerated growth of consumables, the supplies that are used every time an instrument was used, which represented 65% of total revenue.
Growth of Illumina's consumable business reflects two factors that should lead to more superb results for a while: strong underlying demand for sequencing and the early stages of a very successful product cycle.
Diagnostic and consumer applications are creating a wave of demand
Illumina reported strong demand for consumables across its product lines, but there are some clear trends that are pushing up the usage of its machines, and will continue to do so for years to come. In the early days of sequencing, usage was driven by researchers pushing the envelope of knowledge about the human genome. But Illumina's sequencers are increasingly being used in commercial diagnostic applications, as detail of a patient's DNA becomes a critical part of precision medicine. Clinical and translational customers accounted for 45% of Illumina's shipments in 2017, compared with 39% in 2016.
At the top of the list for diagnostic applications is non-invasive prenatal testing (NIPT), which has been a growth driver for the company for several years now, especially in China. Illumina introduced VeriSeq CE-IVD for NIPT in mid-2017, and sales have been outpacing the company's expectations.
But NIPT was just the beginning. Regulatory and reimbursement decisions are opening doors for new clinical adoption, and Illumina has its MiSeqDX and NextSeqDX systems positioned to take advantage of the opportunity. Advances in immuno-oncology are opening up uses for the company's sequencers to personalize treatments for cancer.
Last year, the FDA approved, for the first time, a cancer treatment indicated for a specific genetic feature of the tumor, independent of where the tumor originated. Up to this time, the FDA had only approved treatments for cancers based on where the disease originated. The decision to approve a treatment based solely on a genetic feature of the tumor was a big step forward for precision medicine, and toward making Illumina's instruments essential tools in the fight against cancer.
The FDA has also approved genomic-based companion tests for oncology therapies, and Medicare has expanded reimbursement for genomic testing to all solid tumor types, covering 55 million people. In recent months, Illumina has announced collaborations with Loxo Oncology and Bristol-Myers Squibb to develop companion diagnostics in oncology, and these are probably just the beginning.
Illumina's instruments are also being used to perform whole-genome sequencing on newborns with rare and undiagnosed diseases, led by Rady Children's Institute for Genomic Medicine in San Diego. Illumina recently acquired Edico Genomics, a small company that makes specialized, PC-based computers for high-speed processing of genomic data, and they are used by Rady's for rapid delivery of genomic insights for critically ill newborns.
Spin-off Grail is getting traction
One of the biggest clinical opportunities on the horizon, though, is in liquid biopsy. Illumina gave the field a boost when it founded and then spun off Grail, which is working toward a blood test that can detect multiple forms of cancer before the disease manifests itself in any other way. The approach requires massive amounts of sequencing data, and Illumina said that in 2017, Grail was already one of the company's largest customers.
Grail is just getting started. In April, it announced early results from its first study, and they were promising. Blood samples were taken from 878 patients with newly diagnosed but untreated cancer, and 580 patients without diagnosed cancer. One of the prototype assays detected cancer in 65% of the patients with stage I, II, or III cancer and 95% of the patients in stage IV. Of the patients with no diagnosis, five returned a positive signal, and of those five, two have subsequently been diagnosed with cancer. Ultimately, the plan is for the study to enroll 15,000 patients with a primary completion date of September 2018. That's going to take a lot of consumables, and more studies will follow.
Consumer genomics are also booming and are largely responsible for 44% growth in services last quarter, now accounting for 20% of total revenue. These products used to cater to curiosity about genealogy or sensitivity to caffeine. Now these services are turning toward health and wellness. In March, the FDA cleared 23andMe for a direct-to-consumer cancer risk test, and Illumina's Helix subsidiary offers food sensitivity testing and genetic testing for a couple of rare metabolic diseases, and it will soon offer risk assessments of prostate cancer and cardiac disease.
The early stages of a product cycle
Against the backdrop of rising industry demand, Illumina is simply executing well. At the beginning of 2017, the company introduced NovaSeq, its new, top-of-the-line sequencer. The transition went very smoothly last year, with no production delays, and demand has remained strong. NovaSeq has kicked off a multiyear upgrade cycle as customers replace their older machines with the faster, more versatile units. So far, only 15% of the 850 customers with HiSeq and HiSeq X, the older, high-end models that NovaSeq will eventually replace, have bought their first NovaSeq machine.
And upgrades aren't the only source of demand, with about 25% of NovaSeq sales coming from new-to-sequencing customers or those who are moving up from smaller, less expensive benchtop gene sequencers. Illumina expects to sell between 330 and 350 of the million-dollar NovaSeq systems in 2018, and consumables sales are ramping fast, increasing 60% sequentially in Q1, excluding a big stocking order in Q4.
Illumina also strengthened the low end of its offerings earlier this year by introducing iSeq, a $20,000 benchtop unit with a price per sample of between $25 and $150. Existing customers will buy iSeq for small-batch runs, but Illumina expects the products will attract new customers and new use cases, such as monitoring for hospital-acquired infections and testing for food-borne pathogens. iSeq is in beta testing now, and it will be a number of quarters before sales amount to enough to materially affect Illumina's results.
Expensive, as usual
Illumina is riding a wave of increasing demand for gene sequencing and is well-positioned with products to capitalize on it. But is the stock a bargain now? No, but Illumina rarely is. As the graph of the trailing price/earnings multiple below shows, the valuation has been gradually increasing since the debut of NovaSeq early last year. But to put that in context, the last launch of high-end sequencers in early 2012 sent Illumina's multiple even higher than today's for three years following.
Considering that the company is poised to benefit from both long-term and near-term trends, I think the stock has a good chance of staying expensive for a while. Investors could wait for a market pull-back to get a better price, but with a quality company like Illumina, it could be a long wait. Illumina is a buy, even at this price.