It gets harder and harder to criticize a company's valuation when that company continues to surpass expectations and build its lead on its rivals. That is the basic story for Illumina (NASDAQ:ILMN), as this company continues to distance itself from Thermo Fisher (NYSE:TMO) and other would-be sequencing competitors and build up its bona fides in the diagnostics market. With a diagnostics opportunity at least twice as large as the $2 billion sequencing market (and growing at a double-digit rate), there seems to be enough growth potential to keep investors keenly interested in this name.
Another excellent quarter
Illumina reported 27% revenue growth for the first quarter, coming in 7% ahead of sell-side expectations with strength across the board. Instrument sales rose 32%, while consumables rose 18%. The sequencing business was particularly strong, with instrument revenue up 42% and consumables revenue up 58%.
While GAAP gross margin did decline slightly, adjusted gross margin rose 1.2 percentage points and the company beat Street estimates by more than a point. Operating income was likewise quite strong; Illumina's own adjusted operating income showed 34% growth while "adjusted adjusted" figures that include stock comp expense point to 32% growth. Either way, Illumina was well ahead of expectations.
From strength to strength
Illumina has gotten itself on quite a roll when it comes to new equipment/systems and the company continues to expand its addressable market. The company stated that about 70% of its HiSeq orders in the quarter were from new customers, while the shipment of 65 NextSeqs suggests a launch well ahead of the MiSeq. Importantly, it doesn't look like NextSeq is cannibalizing existing business and about half of the orders were from non-academic customers.
What's more impressive is that while it is normal for the early market champion to see its lead whittled away over time, Illumina appears to be extending its lead. Presentations from Thermo Fisher's Ion Torrent have been less energetic than in the past and while some of that may be due to a difference in communication policies and philosophies since Thermo bought Life Sciences, it could also reflect the fact that Ion Torrent's market power has definitely been waning.
Other rivals likewise are struggling to make a dent in Illumina's momentum. Pacific Biosciences (NASDAQ:PACB) has significantly improved its chemistry and consumable pull-through is accelerating nicely. What's more PacBio is looking to more than double its read-lengths over the next two years while quadrupling throughput. Even so, this isn't much of an issue for Illumina – PacBio has chosen to focus its efforts largely outside of Illumina's core markets and concentrate on applications like plant genomics, epigenetics, and "platinum" sequencing.
Oxford Nanopore continues to loom as a threat, but analysts and scientists have been watching and talking about ONT for a long time now, with not a lot to show for it. While electronic-based sequencing may indeed emerge as a competitor to chemistry-based sequencing, it's not there yet. Likewise, Bio Rad and Qiagen may be paying more attention now to the clinical diagnostics potential of sequencing, but they are well behind Illumina.
Diagnostics developing, but it will be a battle
The role of sequencing in clinical diagnostics is still relatively minor. Illumina is making a push into non-invasive prenatal diagnostics and many centers are performing tumor genetic profiling on a relatively routine basis. As pharmaceutical companies continue to develop oncology drugs that work on the basis of very specific genetic variations, this opportunity could certainly grow.
As the market grows, so too will the interest of Illumina's competitors. Roche and PacBio have already teamed together on an effort to develop a human clinical diagnostics platform based on PacBio's technology, and readers may well remember that Roche tried to acquire Illumina not so long ago. Qiagen and Bio Rad are both pursuing clinical diagnostic applications of sequencing, and it seems reasonable to assume that Thermo Fisher will try to follow. There is also the potential for large existing diagnostic companies like Abbott, Becton Dickinson, and Hologic to acquire or partner their way into the sequencing-based diagnostic opportunities.
The bottom line
The challenge with Illumina's stock remains basically the same – very few companies can deliver the sort of growth that seems to be priced into these shares. Illumina's trajectory, its lead on its rivals, and its large and growing addressable markets suggests that it can be one of those few, but there's definitely execution risk with a stock that prices in over 20% annual free cash flow growth for the next decade.