2023-07-19 17:33:55 ET
Summary
- Illumina's financial performance is deteriorating due to macro factors such as COVID-19 related supply chain disruptions and the Ukraine conflict. The company's net debt is at a record high and net margin at a record low.
- The company is facing regulatory issues related to its acquisition of GRAIL, including ongoing legal proceedings and a $476 million EU antitrust fine. CEO Francis deSouza recently stepped down.
- Illumina's stock price is downtrending. However, the firm recently hit some new milestones, including an international privacy certification for six bioinformatics programs and above average demand for NovaSeq X.
About
Illumina, Inc. ( ILMN ) provides DNA sequencing, consumable kits (whole-genome and targeted resequencing), arrays with customizable substrates, bioinformatics, and a variety of other services related to genomic analysis. As their FY-2022 10-K explains:
Most of our product sales consist of sequencing- and array-based instruments and consumables, which include reagents, flow cells, and library preparation, based on our proprietary technologies…
…Our DNA sequencing technology is based on our proprietary reversible terminator-based sequencing chemistry, referred to as sequencing by synthesis ((SBS)) biochemistry…
Our BeadArray technology can perform many assays simultaneously… we can vary the size, shape, and format of the substrate into which the beads self-assemble and create specific bead types for different applications…
Our BaseSpace Informatics Suite…. allowing customers to manage their biological sample and sequencing runs, process and analyze the raw genomic data, and derive meaningful results.
In Q1-2023, 70% of total revenue came from consumables, 14.5% came from instruments, and the remaining 15.5% came from services/other revenue, according to the recent 10-Q .
The company recently acquired a healthcare firm called GRAIL and is involved in ongoing legal proceedings. As the 10-Q notes:
On August 18, 2021, we acquired GRAIL… The acquisition is subject to ongoing legal proceedings and, currently, GRAIL must be held and operated separately and independently from Illumina pursuant to interim measures ordered by the European Commission, which prohibited our acquisition of GRAIL on September 6, 2022.
Elevator Pitch
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Illumina’s net debt (quarterly) is at a record high since 2014, and its net margin (LTM) is at a new low for the company since that time, sitting at -100%. The firm’s FCF margin (LTM) is also at a record low after falling negative for the first time last quarter (Q4-2022).
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COVID-19 related supply chain disruptions and other macro factors (including the Ukraine conflict) continue to adversely affect the firm. Customers have been “managing tighter inventory” in response to unfavorable conditions.
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The firm recently paid a record antitrust fine related to the GRAIL acquisition. Its stock price is in a downtrend, and last month, the company announced that its CEO Francis deSouza is stepping down after serving for 10 years.
Decaying Financials
ILMN’s revenues (LTM) peaked in Q3-2022, ending a 7-quarter long uptrend. Its operating income (LTM) hit a record low this quarter and has been negative and downtrending since Q3-2021. Net income (LTM) also hit a record low this quarter, and it has been negative for three quarters in a row, the longest losing streak since at least 2014. FCF peaked at $1b in Q2-2020 and went negative in Q4-2022.
The firm’s EBITDA margin (LTM) has been downtrending since Q3-2015 and is down about 67%, falling from 39% to 13.5%. Operating margins (LTM) have been negative for seven quarters in a row and are fairly elevated, now close to -100%, a record low. The company’s FCF margin (LTM) has been negative for two quarters in a row, and is at a record low of -5.13%.
Asset turnover has been downtrending since Q4-2015 and is down 48% since that time. The firm’s ROE (LTM) has reached a record low of -51%, the third negative value in a row. ILMN’s number of common shares is at a record high, and has risen 25% since 2014.
Net debt is at a record high since 2014 and is sitting at $797m, compared to its low of -$2.5b in Q2-2021.
Elevated Valuations
Based on P/S, P/B, and EV/S, the firm’s valuation is on average 22.6% above its industry median. Meanwhile, its profitably metrics fall into the bottom 35% of its industry group.
Potential Catalysts & Signs of Deterioration
Illumina is still involved in legal proceedings related to its acquisition of GRAIL. Based on the firm’s Q1-2023 10-Q, The FTC alleged that Illumina’s GRAIL acquisition defied statute 15 U.S.C. § 18 in March of 2021. The judge’s decision favored Illumina in September of 2022, but in March of 2023 the FTC issued an order stipulating that Illumina divest GRAIL. The firm is hoping for a review of this order by the Fifth Court of the U.S. Court of Appeals, and chose to file a petition in late April 2023. Since then, the Fifth Court accepted the briefing schedule Illumina proposed, and the firm expects to be replying to the opposing brief from FTC sometime in July of this year.
The company is also facing regulatory setbacks in Europe, and received a $476 million EU antitrust fine (about 10% of Illumina’s global turnover, per Reuters ). For context, the European Commission stated in December of 2022 that it planned to compel the firm to divest GRAIL, claiming the acquisition significantly reduced competition and efficiency in the European marketplace (according to the FY-2022 10-K).
Just last month, the company announced that its CEO Francis deSouza is stepping down after serving for 10 years.
Illumina notes that current macro factors, particularly COVID-19 related supply chain disruptions, continue to adversely affect the firm. The recent 10-K for FY-2022 stated that customers have been “managing tighter inventory” in response to unfavorable macro factors and after having recently faced supply chain problems.
Those factors drove customers to more conservatively manage their capital purchases, in Illumina’s view, and likely explains the drop in annual revenue for Core Illumina instruments. The company is seeing a drop in shipments for its NovaSeq 6000 high-throughput instrument as well as its NextSeq 550 mid-throughput instrument.
In general, Illumina’s financial performance is susceptible to macro risks such as rising interest rates, inflation, supply chain dysfunction, and economic slowdowns (including those related to COVID-19). Their results are also adversely impacted by trade route interruptions to military confrontations between Russia and Ukraine. Any of these variables could continue to remain unsupportive, or could even worsen, in the future.
Risks
Some recent milestones that the firm mentioned on the Q1-2023 press release could result in Illumina outperforming market expectations in the future. The company:
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Obtained an international privacy certification (ISO/IEC 27701) for six bioinformatics programs
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Updated its relationship with Myriad Genetics so that Illumina’s TruSight™ oncology test (intended for research only) can be sold in the US.
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Saw above average demand for NovaSeq X in Q1-2023; Management noted, “We shipped 67 NovaSeq X instruments in the first quarter, exceeding our plan.”
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Completed the launch of Illumina Connected Insights, a sequencing-related software with use cases in oncology and rare diseases.
If any of these events develop enough to cause Illumina to start surprising the market, share prices may start rising and the downtrend in share price may end. Illumina’s share price is already somewhat depressed compared to its recent trading range (from May of 2022 to present). The stock is at $187.15, which is right near the low of its post-May range ($187.29) based on weekly prices. It’s possible that this approximate level could once again act as a support and lead to price reversing its downtrend.
Execution
Shorting a stock is a bet on where its price goes, not necessarily the fundamentals of the business. Since there is statistical evidence of trends in equity markets, investors who apply a scientific mindset should probably focus on shorting companies that are in a downtrend or close to starting one. Then, fundamental and macro factors can be additional requirements investors use to refine their screening process and become more selective.
Illumina’s stock has been in a long-term downtrend since August 2021. It has been in a messy trading range since May 2022 and just recently closed below the low of that range based on weekly prices.
Based on daily prices, the stock is right near the low of its post-May 2022 trading range. The stock has been below its 200-day trailing average since April 27 of this year.
It may be sensible to consider shorting this stock only while the downtrend remains in play, perhaps by requiring that the price stays below its long-term average (perhaps the 200-day, or some other trendline depending on which tests better).
Some investors may want to wait for additional signs that a downtrend is starting, and may consider shorting once the price more aggressively breaks below its range at the daily level.
All else equal, I believe short positions are less likely to succeed than long positions, mainly because downtrends tend to be more choppy and harder to exploit than uptrends. Also, in many market environments, declining stocks are harder to find, and those that are in a downtrend tend to already be at a discount compared to industry average multiples.
That said, I believe it's still worth noting short ideas that have multiple supporting factors (price trend, declining fundamentals, etc).
Bottom Line
Illumina’s financials are deteriorating; its customers are tightening up purchases due to persistent macro headwinds, and the firm is struggling with regulatory resistance to its recent GRAIL acquisition. Based on P/S, P/B, and EV/S, the firm’s valuation is on average 22.6% above its industry median. Illumina's CEO recently stepped down, and the company just paid a record antitrust fine related to GRAIL. While price maintains its downtrend, this stock may be an interesting opportunity for investors who dabble in short positions.
For further details see:
Illumina, Inc.: Collapsing Margins, Rising Debt, Legal Setbacks, And Downward Momentum