The Best Stocks in Gene Sequencing

By Markets Fool.com

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Source: Charles Jencks, Flickr, Creative Commons.

If you're looking for a healthcare segment moving at breakneck speed, look no further than gene sequencing. With an estimated annual growth rate of 23.1%, by 2018 the sequencing market is headed for $11.7 billion, according to BCC Research and MarketsandMarkets.

By the way, that's not taking into account another quantum leap forward in technological capability, something this field is known for. As many have pointed out, in the past two decades, the cost of sequencing has dropped from $3 billion to sequence the first human genome to only $1,000. Faster, cheaper sequencing has led to new killer applications in everything from cancer research to innovative drug development.

Naturally, there's a catch, as well as a risk for investors. Namely, it's almost impossible to find attractive prices in this sector. The staggering potential of DNA sequencing keeps the market piling in. So this sector, however alluring, also commands nosebleed premiums.

If you have a long-term horizon, however, here are two stocks well positioned for future growth. The second one even has a valuation on the down-low, at least for now.

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Illumina rocks the genetics world
The last thing you want in DNA sequencing is a company that sits on its laurels and counts cash. That's something you certainly won't get with San Diego-based Illumina .

Last year, the company introduced a machine, the HiSeq X Ten, able to sequence the human genome for $1,000 and do five genomes in a single day. But even before that, the company owned more than 70% of the next-generation sequencing market. Although there are competitors out there, including Roche , Pacific Biosciences , and Thermo Fisher Scientific , lllumina is by far the dominant player.

What's amazing about Illumina is that it keeps doing what Apple does -- rocking its world by introducing ultra-cool devices and upgrades at a rapid pace. On the heels of record-breaking shipments of sequencers last quarter, the company launched two new gadgets -- the TruSight HLA, designed to end the need for multiple rounds of testing to resolve ambiguous results, and the NeoPrep, a one-stop solution for library prep.

The upshot is that the company has the fastest-growing installed base of sequencing instruments in the world and showsno sign of letting up. Illumina saw EPS growth of 52.2% last year, and it looks great thus far this year, with 71% earnings growth last quarter. Illumina is expected capture up to 74% of the exploding sequencing market, all the way out to 2020.

There are a couple of caveats. The high-end customers Illumina depends on are huge institutions, if not countries, so Illumina is susceptible to government spending cutbacks. In addition, all this potential comes at a high price.

Illumina's trailing P/E ratio is 81.5. When you compare that with the average 12-month earnings multiple of 37.1 for the life-sciences tools and services industry, Illumina is in the 91st percentile.

Investors keep piling in, however, because this stock shows no sign of ever providing a low entry point. Illumina's trailing P/E typically clings tightly to the company's five-year historical average of 80.1.

Meanwhile, a high-end sequencing platform being released by a competitor is probably Illumina's greatest risk, and in fact, it just happened. Just this month, Shenzhen, China-based global genomics corporation BGI announced its first DNA sequencing instrument for the world market at the European Human Genetics Conference in Glasgow.

BGI's Revolocity uses a markedly different sequencing system from Illumina's machine, and BGI slapped it with a $12 million price tag. By contrast, Illumina's XTen, which is actually a battery of 10 HiSeq X systems, sells for $10 million.

With the 20% surcharge, BGI will have an uphill climb to persuade many to adopt its platform's less familiar technology. Nevertheless, the introduction of the system means Illumina no longer has the high end to itself.

Luminex: two big catalysts on the horizon
Compared with Illumina's $31 billion market cap, small cap Luminex is tiny -- worth just $738 million and has only 750 employees. In addition to the risks inherent in any small company, Luminex's growth has been tepid at best. Revenue climbed 2.1% year over year last quarter, to $57.7 million, which was slightly better than the Zack's consensus estimate of $57 million.

But Luminex has two pipeline products with near-term launches and major revenue potential. The first product to launch will be Aries. Executives target FDA submission for this summer, followed by "a commercial launch scheduled for the fourth quarter of this year." The rollout of Luminex's other product, the xTAG Gastrointestinal Pathogen Panel, follows the same timeline.

The genomics industry is highly fragmented into segments and sub-segments. Without getting too into the weeds, Luminex focuses on molecular diagnostics. By analyzing the specifics of a patient and his or her disease, molecular diagnostics offers the prospect of personalized medicine.

Luminex claims that the market for Aries alone represents more than a $1 billion opportunity.Since Luminex currently nets yearly revenue of about $225 million, we're not talking a chicken-feed revenue increase. And while management's launch timeline seems optimistic, the clinical trials for the products are on schedule, with the third one for ARIES commencing last week.

Luminex currently trades at a trailing P/E ratio of 17.8 and a price-to-cash flow ratio of 13.8, both considerably lower than the broader S&P healthcare sector ratios of 32.7 and 20.5, respectively. In addition, while Illumina has been mentioned as an acquisition target -- Roche tried to take it over a few years ago -- Luminex's low valuation could make it a more likely M&A play.

Finally, recent significant insider trades give a possible confirmation of management's high expectations for the product launches. According to SEC filings, Luminex's CEO bought 6,000 of the company's shares on May 28, at an average cost of $16.74 per share. Director Walter Loewenbaum completed a $650,000 order a day earlier, for nearly 39,000 of the company's shares.

In short, Luminex is a company in transition, with two upcoming products whose value seems unrealized. It's a high-risk, high-potential stock to put on your radar, if you want exposure to this field.

The article The Best Stocks in Gene Sequencing originally appeared on Fool.com.

Cheryl Swanson owns shares of Apple, Illumina, and Luminex. The Motley Fool recommends Apple, Illumina, and Pacific Biosciences of California. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.