In the world of gene sequencing, few names carry as much weight as Illumina (ILMN 2.40%). Its sequencing devices are among the most widely distributed in global hospitals and laboratories of all stripes, and its ongoing years-long efforts to develop new technologies place it at the cutting edge of the field, with few notable competitors anywhere in sight.
Despite its leadership, there's plenty of trouble brewing thanks to ongoing legal wrangling with regulatory authorities on two continents and a slowdown in some of its core market segments. Not all is lost; there's still a powerful long-term trend that'll support its share price. But if you're thinking about buying this stock, it'll behoove you to understand the most important two red flags as well as the big green flag that's impacting Illumina today.
Red Flag #1: The Grail acquisition is causing a big headache
Illumina is currently facing some serious legal trouble in the E.U. to the point where it constitutes a red flag for its near-term performance.
In August of 2021, it acquired Grail, a cancer diagnostics biotech, for $7.1 billion in cash and stock. However, E.U. regulators hadn't had enough time to determine whether the acquisition violated its guidelines before the transaction closed, so they instructed the company to keep Grail as a separate entity with an independent management team while they reviewed the deal.
Regulators are apt to block the deal altogether and impose a fine for moving forward without their permission. To prepare for the possible fine, Illumina is setting aside $453 million. And that's not the only problem, either. The U.S. Federal Trade Commission (FTC) is also filing a lawsuit to block the acquisition on antitrust grounds, but it's unclear what the financial penalties might be, if any.
Therefore, if you're thinking about buying this stock, be sure to consider that most of the other companies out there aren't fighting two-front legal battles.
Red Flag #2: Some market segments might be saturated
Another major red flag for the company is that it may be reaching the end of the addressable market in some of its segments, particularly its low-throughput desktop sequencers.
In the second quarter, its low-throughput systems posted flat growth year over year. That's in contrast to the sales of its medium- and high-throughput sequencing devices intended for use in hospitals and biopharma settings, which are still growing at a moderate pace of 20% and 23% year over year, respectively.
If the low-throughput market is saturated, that's a problem because it means Illumina will need to fight competitors for market share by spending more on marketing or by spending more on research and development (R&D) to further differentiate its products. Costs will rise, margins may get thinner, and revenue might be slow to follow. Still, it's important to recognize that the company is still the world's largest and most imposing gene-sequencing business, so its brand name will continue to be an important element of its competitive advantage.
Now let's examine an important green flag that might entice some investors into buying this stock.
Green Flag #1: Sales of consumables are still growing
One massive green flag for Illumina is that as of the second quarter, customers performed 15% more sequencing runs using the business' hardware than they did in the prior year.
In a nutshell, that means customers were using their machines to perform more work. When customers run samples, they need to buy reagents to do so, and it's also plausible that they'd also need to get more frequent maintenance and more sophisticated software to keep up with their higher utilization rate. So, more sequencing runs equals more recurring revenue.
That's key, because in the most-recent quarter, the company brought in $744 million from sequencing consumables alone, up 6% from the prior year and accounting for a huge proportion of its quarterly revenue of around $1.1 billion. In the long term, it simply won't go out of business as long as people rely on its hardware so heavily, even if it reaches the end of its markets for new devices.
Of course, that might not be enough to convince investors to buy the stock given the recent difficulties, but it should provide some reassurance to people who decide to pick up a few shares while the market's sentiment is sour.
