Not that long ago, I wrote an article asking how long investors would tolerate the growth-at-all-costs business model of Twist Bioscience (NASDAQ:TWST). Shares have responded by soaring over 200% in 2020. I nailed it. 

The DNA synthesis company has poured money into a rapid business expansion at the expense of profitability and operating cash flow, which has forced it to fund the business through stock offerings. That's not a sustainable long-term strategy, but it's one investors and Wall Street have come to accept in the era of cheap money. 

As fiscal third-quarter 2020 operating results show, Twist Bioscience is doing an impressive job growing multiple parts of its business. Is that enough for investors to overlook the growth stock's expensive valuation? 

A teaching model of DNA.

Image source: Getty Images.

By the numbers

Twist Bioscience is developing a technology platform for synthesizing DNA. The building blocks of the genetic code are pooled together on silicon chips and combined into accurate sequences. The resulting synthetic DNA can then be used in genetic engineering experiments at industrial biotech, agricultural biotech, and biopharmaceutical companies; used to boost the accuracy of next-generation sequencing (NGS) tools; used in drug-discovery activities; and more. 

Growth certainly hasn't been an issue for the young company. Full-year revenue has grown from $10.7 million in fiscal 2017 to $54.4 million in fiscal 2019. Revenue in the first nine months of fiscal 2020 settled at $57.7 million, although operating losses have grown, too, even when a legal settlement with Agilent Technologies is excluded. 

Metric

First 9 Months Fiscal 2020

First 9 Months Fiscal 2019

Change (YOY)

Revenue

$57.7 million

$38.7 million

49%

Gross profit

$13.8 million

$3.6 million

284%

Operating income

($116.1 million)

($77.3 million)

N/A

Operating income, excluding legal settlement

($93.6 million)

($77.3 million)

N/A

Operating cash flow

($117.0 million)

($76.5 million)

N/A

Operating cash flow, excluding legal settlement

($94.5 million)

($76.5 million)

N/A

Data source: SEC filing. YoY = year over year.

Twist Biosciences is seeing early results from investments in NGS tools and synthetic gene product offerings, including the recent launch of longer gene products (up to 5 kilobases in length). The trend should continue due to overall customer growth and the addition of high-quality customers. 

The hereditary DNA testing company Ancestry.com, which reported over $1 billion in revenue in 2017 (its last year as a publicly traded company before going private again), recently tapped NGS enrichment panels from Twist Bioscience for some of its offerings. It's the first time NGS technology has been used in a consumer product. Here's how revenue breaks down by product:

Product Group

First 9 Months Fiscal 2020

First 9 Months Fiscal 2019

Change (YOY)

Synthetic genes

$33.8 million

$23.8 million

42%

Oligo pools

$3.3 million

$3.3 million

2%

DNA libraries

$3.9 million

$1.6 million

138%

NGS tools

$23.8 million

$14.8 million

60%

 YoY = Year over Year.

The first three product groups are generally lumped together as synthetic biology products, but I broke them out in the table above to show the strength in synthetic genes. Additionally, investors can expect to see DNA library revenue increase in the near future as Twist Bioscience expands drug-discovery deals, such as the one announced with Takeda Pharmaceuticals earlier this year. 

It helps for investors to understand the business by the industries it serves. Twist Bioscience has done a great job attracting industrial biotech and healthcare companies. In the fiscal third quarter of 2020, the business reported healthcare revenue of $8.5 million, up from $3.3 million in the year-ago period and largely a reflection of strength from NGS tools.

Industry

First 9 Months Fiscal 2020

First 9 Months Fiscal 2019

Change (YOY)

Industrial chemicals

$21.5 million

$16 million

34%

Healthcare

$20.8 million

$12.4 million

68%

Academic research

$14.3 million

$9.2 million

56%

Agriculture

$1 million

$0.98 million

2%

Data source: SEC filing.

There seems to be perpetual anxiety on Wall Street regarding the company's dependence on Ginkgo Bioworks (included in the industrial chemicals break out above), but Twist Bioscience has been diluting the customer's share of overall revenue while still maintaining a healthy relationship. Revenue from Ginkgo Bioworks grew from $7.1 million in the first nine months of fiscal 2019 to $8.8 million in the corresponding period of fiscal 2020, but the customer's share of synthetic gene revenue fell from 37.7% to 33.1% in that span.

Then again, investors might expect revenue from Ginkgo Bioworks to significantly increase in the second half of the calendar year, just not for the usual reasons. 

Looking ahead

Ginkgo Bioworks was one of a handful of companies to receive funding from the National Institutes of Health (NIH) Rapid Acceleration of Diagnostics (RADx) program to increase the nation's COVID-19 testing capacity. The company received $40 million to convert a portion of its automated laboratories in Boston to process up to 50,000 tests per day by September 2020 and up to 100,000 tests per day by the end of 2020. 

Most importantly, Ginkgo Bioworks is leveraging NGS tools to meet those goals. That figures to provide a meaningful boost to Twist Bioscience's NGS revenue in the next several quarters, although management declined to discuss specifics on the third-quarter 2020 earnings conference call. It might only provide a temporary boost to revenue, but it's something for investors to watch nonetheless.

An arrow jumping up shelves on a wall.

Image source: Getty Images.

Do stock valuations matter in 2020?

To be blunt, my arguments that investors should be wary of Twist Bioscience's growth-at-all-costs business model haven't held up very well to date. Wall Street appears content with the company's pursuit of growth at the expense of inching closer to profitability. That said, given some of the irrational stock market valuations this summer, it's still worth considering if the recent run-up in share price is sustainable.

Right now shares of Twist Bioscience are trading at 30 times sales -- roughly double the valuation from my cranky arguments to date. That might be palatable if the business were profitable or close to it, but it's difficult to justify that valuation even at current growth rates. The business would have to grow annual revenue at a 35% clip through fiscal 2023 just to make the current share price valued at historical price-to-sales ratios.

Twist Bioscience could pull that off, but shares are going to have to slow down and let valuation metrics catch up eventually. Simply put, the company's current valuation is detached from business fundamentals and suggests now's not the best time to start or add to a position. Then again, I've been wrong so far about investors' appetite for growth at all costs.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.