Illumina
Moat: 3/5
Understandability: 4/5
Balance Sheet Health: 3/5
Illumina is a global leader in DNA sequencing and array-based technologies, serving customers in the research, clinical and applied markets, providing products and services across various genomic applications.
Investor Relations Previous Earnings Calls
The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.
Business Overview Illumina is a biotechnology company that develops, manufactures, and markets integrated systems for genetic analysis. Their core products are next-generation sequencing (NGS) systems and microarrays, along with associated reagents, consumables, and data analysis software. These tools are utilized in a broad range of applications, including clinical diagnostics, pharmaceutical research, drug development, agricultural genomics, and consumer genomics.
Illumina generates its revenues from two primary segments. Core Illumina, which includes products and services related to sequencing and array instruments used in the research, clinical, and applied markets. And GRAIL, a healthcare company that focuses on early detection of multiple cancers through genomic testing that was acquired in August 2021. The acquisition of GRAIL, which is discussed later, is a major and a more recent development for the company.
In 2023, the Core Illumina segment generated $3,501 million (81.8%) of total revenue, and GRAIL revenue was $771 million (18.1%), for a total revenue of $4,285 million for 2023. The revenue is relatively diversified geographically, with 49% from North America, 27% from Europe, Middle East, and Africa, and the remaining 24% from Asia-Pacific.
A significant portion of Illumina’s revenue is derived from consumables, which are recurring revenue streams, including reagents, assays, and other disposable items required for instrument usage, which implies a level of stickiness with the customers, since once the instruments are there, they will have to continually use the company’s items.
The company’s financial position is generally positive, with operating expenses being around $3.7 billion in 2023, gross profit is around $2.9 billion with a gross margin of 67% in 2023 and R&D expenses which are a large portion of the expenses, accounting for 24% of revenue. However, the company had a loss from operations of approximately $700 million in 2023. While Illumina continues to see strong growth in revenue and gross profits, they have been seeing some difficulties on the profitability side due to ongoing operating expenses, legal proceedings, and other expenses related to their acquisition of GRAIL. From what we could gather from 10-k filings, and from looking at the consolidated statements of operations, the costs of revenues as well as SG&A have grown from 2021 to 2023. And this is mainly in relation to their headcount growth and higher cost structures.
Competitive Landscape: Illumina operates in a competitive market with several other players, including Thermo Fisher Scientific, Agilent Technologies, and Pacific Biosciences. While the competition exists, Illumina possesses a significant market share in the industry, driven by its innovative technology, brand reputation, and broad range of applications.
The company has what is called an “economic moat,” which is derived from its technological innovation and expertise in DNA sequencing and array-based solutions. Their strong brand name and established customer base also act as advantages, making it difficult for new entrants to gain a foothold and compete on equal terms, but it is not insurmountable. They also face competition from other providers offering sequencing and microarray instruments. The company competes primarily on the basis of performance of our instruments and assays, breadth of our product offerings, new product and services development capabilities, brand name, manufacturing capabilities, and regulatory expertise and support.
What makes Illumina Different: Illumina’s competitive advantage rests primarily in its industry-leading next-generation sequencing (NGS) technology, which provides higher throughput, lower costs, and more flexibility than competitor technologies. It also includes various proprietary software and data analysis capabilities which provide customers with end-to-end solutions. The scale is also one of its advantages, as it is the largest player in this market.
A central theme throughout their documentation, earnings calls and interviews, is that Illumina see themselves as being in the forefront of a biological revolution, and are continually trying to improve their technologies and their reach. This belief that they are at the forefront of something big and will make it mainstream, is a large factor in their moat.
Financials: In 2023, Illumina recorded total revenues of $4.285B, with product revenue accounting for $3.501B, which made up 81.8% of the total revenues, and the rest was mainly through services. This represents a 3.6% increase in their total revenues over 2022. Illumina’s gross profit margin for 2023 was 67.0%, which remains healthy.
- Operating Expenses: Operating expenses in 2023 were $3.7 billion which includes $1.16 billion in research and development (R&D). R&D expenses are a high portion of their overall expense and are meant to ensure future value creation. The company’s SG&A expenses increased from 1.25 billion in 2022 to $1.438 in 2023, partially because of costs related to the acquisition of GRAIL.
- Profitability: Illumina’s profit from operations decreased significantly, and resulted in a loss from operations of $700 million. This is in line with a general trend in the company’s financial numbers since 2021, wherein, even though the revenues have been increasing, the company’s profit margins have deteriorated.
- Cash Flows: The cash flows from operations were roughly $700 million. In terms of free cash flow (FCF), the company had a negative free cash flow of $167 million in 2023, due to higher investment into working capital, and capital expenditures.
- Balance Sheet: As of December 31, 2023, Illumina had $1.1B in cash and cash equivalents, and the net debt is roughly $1.5 billion. The debt has been primarily in the form of term notes and convertible debt, which are likely to be repaid in the next 2 to 3 years.
Risks to the Moat and Business: Several factors could pose risks to Illumina’s moat. Technological changes are a major factor. The rapid pace of innovation in genomic technology means that the company faces the risk of a competitor developing a better sequencing technology that could render Illumina’s current technologies obsolete. Another major risk comes from ongoing litigation and regulatory issues, particularly in relation to their acquisition of GRAIL, and their attempts to sell off the company. This issue is causing a high amount of non-recurring expenses for the company, which can materially affect its financials. The company’s performance will also be dependent on the macroeconomic and political environment, as changes in trade policies and foreign currency markets may also create problems for the company.
Business Resilience: Despite the challenges mentioned above, the company’s market share and moat remain intact. Their ability to continue generating recurring revenues through consumable sales, in conjunction with their ongoing innovation efforts and large amounts of R&D spending provide an important backbone to protect the company from long-term decline. They are focused on generating value and improving shareholder returns through their “new” company structure, meaning, the core Illumina business with GRAIL being a separate segment. However, further performance still relies on their ability to handle the legal and regulatory hurdles of the GRAIL acquisition, alongside market challenges.
Understandability: I am rating the understandability a 4 out of 5, which is a little above average. The overall idea of the company and its industry is relatively easy to grasp, since most people have some basic knowledge of genomics and DNA sequencing. The core business is very easy to understand, wherein they produce the systems, and then sell the consumables to support the systems. However, the company’s financial statements are very complicated, due to their acquisitions and various other accounting changes.
Balance Sheet Health: I’m rating the balance sheet a 3 out of 5, which is relatively average. The balance sheet is far from being terrible, but it does have some issues. The total debt is higher than the total cash, and the recent lawsuits and acquisitions have added a lot of uncertainty. And, although the total assets are still very high, they did drop compared to the previous year. The company needs to be careful in its investments and spending going forward, in order to protect shareholder returns and to bring the company to sustainable positive profitability.
Recent Concerns: Since its acquisition, the company is facing multiple ongoing litigations and regulatory battles, primarily from the Federal Trade Commission, and the European Commission in relation to the acquisition of GRAIL. They have been told to divest GRAIL, and are currently seeking buyers for the business. Management believes this outcome is detrimental to shareholder value, and they had been trying to reverse the process, while trying to achieve their stated goals, and grow both the core Illumina and the GRAIL business. Additionally, the company has faced other concerns such as declining margins and earnings, alongside a large amount of share dilution. They have been taking steps to improve their bottom line, including cost optimization, and reductions in operating expenditures. However, it will take time for the improvements to show. Also, with the change in management with the new CEO, they also now face some uncertainties about future strategy. The new CEO appears to have a more growth based perspective for the company, and has talked about various acquisitions that might help reach that goal. They are focusing more on the long-term view, however, they face difficulties in achieving both long term and short term goals.
To summarize, Illumina is a leader in its industry with a durable, but not insurmountable moat, and faces various headwinds that it needs to face in order to fully utilize its potential. Their future hinges on their ability to overcome these challenges.