If you've ever had your genes sequenced via a healthcare provider or genealogy service, there's a good chance that your sample was processed using one of Illumina's (ILMN -1.28%) sequencing machines. The company's global dominance of the sequencer market is doubtlessly one of the main reasons for investing in its stock, and with the importance of genetic information only increasing over time, it's an obvious candidate for a long-term hold -- except for its stock's stark underperformance, that is.
With its shares declining by 26% over the last three years in comparison to the market's gain of 45%, even more patient investors might be starting to get nervous about the company's future. Now, with one of its growth-oriented acquisitions in danger and its financial performance flagging, questions about its future are swirling. Is it still a buy, or is this business starting to buckle?
Problems are mounting, and some are self-inflicted
The biggest reason to avoid buying Illumina stock right now is that one of its core markets is looking like it's starting to get tapped out. The company makes three classes of gene sequencers: low throughput, medium throughput, and high throughput. And, as of the second quarter, its sales of low-throughput devices are flat relative to a year ago.
That's an issue, as each sequencer it sells implies a stream of recurring revenue earned from sales of consumables and maintenance services. In 2021, that meant around 80% of its revenue was recurring. But without steady sales and installations of new hardware, it'll be hard to grow revenue from consumables by much faster than the 6% year-over-year increase it posted in the second quarter.
On top of that, there are the discouraging downward revisions in the company's outlook. In its Q1 update, management indicated that total revenue would grow by as much as 16% for the year. But in its second-quarter earnings report on Aug. 11, it revised its guidance downward to a mere 4% to 5%.
Then there's the company's ill-fated acquisition of Grail, a cancer testing start-up originally spun out of Illumina. A year ago, regulators in the EU started to investigate the purchase in light of antitrust laws, and Illumina moved forward with the transaction without waiting to hear back from them. Now, it could face hundreds of millions of dollars in fines, and on Sept. 12, regulators could vote to nix the deal and obligate it to spin off Grail once again.
From a contrarian perspective, the regulatory difficulties could provide an opening to buy the company's shares more cheaply than would be possible otherwise. Still, the whole point of the acquisition is to generate top-line growth while diversifying into new market segments, which won't be able to happen as expediently if it isn't allowed to own Grail.
A wipeout is unlikely, but slow growth could be the norm
As grim as the above factors might sound, it's key to keep these issues in the appropriate context. Grail only generated $12 million in revenue in Q2 despite operating expenses of $156 million, so it isn't helping Illumina's bottom line whatsoever, and it probably won't be for a good while even if it's allowed to stick around. Plus, the company has already set aside $453 million to account for the fines that EU regulators may levy for moving forward with the Grail deal, and it still has nearly $1.3 billion in cash.
Most importantly, there are more than 20,000 of its gene sequencers installed in laboratories and clinics worldwide, and every one needs its owner to keep purchasing consumables to stay in action. That means Illumina's base of revenue is largely safe in the near term, even with flagging low-throughput sequencer sales and the possibility of losing its income from Grail.
Nonetheless, that isn't a reason to actually buy the stock. In a nutshell, the long-term investing thesis for buying Illumina stock today is that it'll likely continue to keep deploying its sequencers worldwide, harvesting larger recurring revenue flows over the years in the process. At the same time, using its domain knowledge and a copious amount of research and development (R&D) spending, it'll defend itself from competitors by continuing to build its software and genomic analysis ecosystems to lock customers in.
Until then, however, investors probably will be stuck with market-underperforming growth as the slow march of device installation takes time to pay off. If you're looking for a growth stock and willing to hold your investment through some near-term chop, now is a decent time to buy for a several-year-long hold. But if you're worried about sleeping at night because you can't stand to see your shares drop, it's probably a better idea to look elsewhere.
