Illumina Stock Now Worth a Lot Less? Here's What You Need to Know

By Rich Smith Markets Fool.com

Wednesday dawned cold and bleak for Illumina (NASDAQ: ILMN) investors, as the maker of gene sequencing equipment received its second dose of bad news from Wall Street in a week.

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One week ago, Illumina stock got shocked by a price target cut (to $100) at Morgan Stanley, which criticized the company's weak revenue and growing competitive threats. That cut sparked a near-5% sell-off in Illumina stock. Today, it's Leerink taking a whack at Illumina, and cutting its price target from $145 to $114 -- and once again, Illumina stock is tumbling.

Here's what you need to know about what Wall Street thinks of Illumina stock.


GATTACA. For Illumina, it's more than a movie. It's a business model. Image source: Getty Images.

1. Sequencers are stalling

Both Morgan Stanley (a week ago) and Leerink (today) focus on weakness in Illumina's high-frequency sequencers (HiSeq) business. As explained in a StreetInsider.com write-up on the rating, Morgan cut Illumina stock based largely on a perceived "recent decline of the HiSeq installed base" combined with "flat HiSeq placements." These trends, warn Morgan, create a risk to Illumina's consumables business, as fewer machines in service will demand fewer consumable materials to operate.

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Adding to the concern, Leerink is warning today that the weakness in HiSeq "utilization" will continue into 2017.

2. No quick turnaround

Perhaps far into 2017. As Morgan wrote last week, its survey of the gene sequencing industry suggests that big pharma isn't spending as much on gene sequencing equipment as investors would like to see, and academic funding, too, remains "challenged" in both the U.S. and European markets. Looking down the road, Morgan sees this trend continuing for "at least 3 more quarters."

3. Competition is rising

Adding to Illumina's troubles, Morgan noted last week that Illumina's customers are beginning to gravitate toward competing products from Thermo Fisher Scientific (NYSE: TMO) and Qiagen (NASDAQ: QGEN). Among the customers' concerns, says the analyst, is a perception that Illumina's rivals produce instruments with lower costs for consumables -- the profitable "blades" in Illumina's razor-and-blades business model.

Given that Illumina depends on consumables to produce nearly 60% of its revenue stream, you can see why customers might balk at the disproportionate cost of consumables, and why a move by customers to avoid rising consumables costs might threaten Illumina's business.

The most important thing: Valuation

Slipping slightly in response to Leerink's downgrade, Illumina stock now sells for just under $127 a share. As such, both the price targets offered by Morgan Stanley last week ($100) and Leerink today ($114) promise price declines for Illumina stock. Despite its steep cut in price target, however, Leerink isn't recommending that investors actually sell the stock (rating it only market perform).

Morgan isn't so sanguine, however. In addition to slashing its price target last week, that analyst actually recommends selling Illumina stock, and rates it underweight. So which of these analysts is right?

Well, let's see here. Valued on GAAP earnings, Illumina stock currently costs nearly 42 times earnings. That's right in the middle between the valuations of Thermo Fisher stock (29 times earnings) and Qiagen (56.5). And yet, most analysts see little difference in the growth rates of these stocks.

According to data from S&P Global Market Intelligence, both Illumina and Thermo Fisher are pegged for 12% growth rates over the next five years, with Qiagen not far behind at 11%. On the one hand, that actually suggests that all three of these stocks look overpriced relative to their growth rates. On the other hand, it also tells me that Illumina stock is perhaps the most overvalued of the three.

Why? S&P Global data shows that while clearly overpriced, Thermo Fisher and Qiagen can both at least boast of free cash flow levels superior to their reported GAAP income. Thermo Fisher generated $2.7 billion in real cash profits over the past 12 months (37% ahead of GAAP earnings of $2 billion), while Qiagen generated $243 million in FCF -- more than twice its $118 million in reported income. This suggests that while expensive, Illumina's rivals are at least slightly less overpriced than they appear on the surface. In contrast, Illumina generated only $434 million in free cash flow over the past year, which is less than its $443 million in reported income. Result: Illumina stock both looks expensive when valued on GAAP earnings...and looks more expensive when valued on free cash flow.

For this reason, in addition to all the other reasons the analysts named, I find myself in agreement: Illumina stock is overpriced, and should probably be sold.

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Fool contributorRich Smithdoes not own shares of, nor is he short, any company named above. You can find him onMotley Fool CAPS, publicly pontificating under the handleTMFDitty, where he currently ranks No. 345 out of more than 75,000 rated members.

The The Motley Fool owns shares of and recommends Illumina. The Motley Fool recommends Qiagen. 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.