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Is Illumina a Buy?

Keith Speights, The Motley Fool

No company has dominated gene sequencing like Illumina (NASDAQ: ILMN). And the stock's performance has reflected that dominance. Illumina's share price has skyrocketed more than 850% over the past 10 years. 

Success isn't just a thing of the past for Illumina, though. The stock jumped more than 37% in 2018 thanks in large part to continued momentum for its latest gene-sequencing system, NovaSeq. But is Illumina a great pick for investors to buy now? 

Magnifying glass with image of DNA helix over multi-colored genetic analysis

Image source: Getty Images.

Reasons to buy

There are basically two assumptions you have to make to buy Illumina stock. First, you have to believe that the growth opportunities in gene sequencing are significant. Second, you have to think that Illumina is well positioned to capitalize on those growth opportunities enough to drive its share price higher.

The first assumption is pretty much a no-brainer. Illumina CEO Francis deSouza stated at the J.P. Morgan Healthcare Conference in January that in the future "the ubiquity and impact of genomics will dwarf everything we've seen to date." He's almost certainly right.

Although significant progress has been made, only a small fraction of human genomes have been sequenced. Very few genetic variants have been characterized using gene sequencing in relation to the total number of possible variants. There are tremendous growth opportunities for gene sequencing in a number of areas, including consumer genomics, non-invasive prenatal testing, population genomics, personalized medicine, and rare and undiagnosed disease research and treatment.

One of the biggest opportunities is in the use of gene sequencing in analyzing liquid biopsy for the early detection of cancer. Some predict that liquid biopsy could be a $100 billion market in the future.

What about the second assumption that Illumina should be able to capitalize on these opportunities? This one might not be a no-brainer, but it seems like a pretty good bet. Illumina is already a market leader in virtually all of the categories listed as potential areas for growth. 

Illumina's short-read sequencing technology is respected in the industry for its high levels of accuracy and throughput. The company is opening up gene sequencing to new customers with its NovaSeq and iSeq systems. Illumina even thinks that it will be able to lower the cost for sequencing a human genome from around $1,000 to $100 in the not-too-distant future using the NovaSeq platform.

The company's strong financial position, with consumables generating an impressive amount of cash flow, arguably should enable Illumina to stay at the forefront of gene sequencing. Illumina continues to invest nearly 19% of revenue to research and development. Illumina also has the financial flexibility to make strategic acquisitions, such as its pending buyout of Pacific Biosciences of California that gives the company a presence in the long-read sequencing technology arena.

Reasons to stay away

There are also reasons investors might choose to avoid Illumina. Probably the two top factors for not buying the stock are its valuation and the potential for disruptive competition.

Illumina isn't cheap by any measure. The stock trades at nearly 55 times trailing 12-month earnings and over 40 times expected earnings. Even incorporating five-year growth projections into the equation doesn't help very much: Illumina's price-to-earnings-to-growth ratio is 2.18. 

Perhaps the scariest prospect for Illumina, though, is that its technology could be rendered obsolete by a competitor. Privately held Oxford Nanopore is one rival that hopes to dethrone Illumina. The company uses a process called nanopore sequencing. Oxford Nanopore's devices are small -- one is the size of a desktop PC while another is a handheld device. The accuracy levels of its systems don't match Illumina's, but the company continues to make progress on that front.

There are other rivals for Illumina, too. Chinese genomics company BGI has stated that it intends to offer human genomic sequencing at a cost of less than $300 by 2020. Roche, which attempted to acquire Illumina in 2012, is a major player in the gene-sequencing market and is researching nanopore sequencing.

Decision time

So do the reasons to buy Illumina outweigh the reasons to stay away or vice versa? Let's look more closely at the objections to the stock.

Yes, Illumina has a sky-high valuation. However, it's important to note that the company's current earnings multiples are actually lower than they've been on average over the last 10 years. 

The tougher question to answer is whether Illumina's technology might be swept aside by competitors. However, Illumina's acquisition of PacBio should help the company fend off competition to some extent. And Illumina was even an early investor in Oxford Nanopore, although its exact stake in the company isn't known.

My view is that knowns for Illumina -- including the tremendous opportunities and its leading position in the industry -- are bigger factors than the unknowns about the potential for more competition in the future. I think Illumina is a buy.

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Keith Speights owns shares of Illumina. The Motley Fool owns shares of and recommends Illumina. The Motley Fool recommends Pacific Biosciences of California. The Motley Fool has a disclosure policy.