Here's Why the Best Is Yet to Come for Illumina, Inc.

By Keith Speights Markets Fool.com

A cursory glance at the stock chart for Illumina, Inc. (NASDAQ: ILMN) might make you think the good times are over for the genomic-sequencing leader. After tremendous gains for much of the past decade, Illumina's share price has gone up and down without making much overall progress during the past three years.

Continue Reading Below

Don't count Illumina out, though. Here's why the best is yet to come for the company.

Image source: Getty Images.

Business model

Illumina basically has a genetic version of the old razor-and-blade business model. In this case, the equivalent of the razor is the company's genomic-sequencing systems. Granted, they're expensive razors, with price tags ranging from around $50,000 to $10 million. What are the "blades" for Illumina? Consumables used by the sequencing systems.

In 2016, Illumina made just under $2.4 billion in revenue. Sales of consumables generated roughly two-thirds of that amount.Illumina should be able to make a small profit even if it doesn't sell a single new system. Of course, though, the company will sell new systems.

Continue Reading Below

But Illumina had this same business model in place over the past three years, when the stock floundered. Why does it make a difference in the company's future success? It comes down to cash flow.

Because of Illumina's solid business model, the company generated operating cash flow of more than $687 million last year. That's a lot of money to reinvest in the business and return to shareholders in the form of stock buybacks. Over time, both actions should help set up the company for more success.

Innovation

One of the most important ways Illumina uses its nice cash flow generated by its solid business model is to innovate. Illumina's continual innovation is probably the biggest reason I think the company's best days are in the future and not the past.

Illumina recently unveiled the latest example of its innovation. The company launched NovaSeq, the next generation in next-generation sequencing systems. The NovaSeq 6000 started shipping in the first quarter of 2017 at a list price of $985,000. The NovaSeq 5000, which will cost $850,000, begins shipping in early 2018. Illumina also plans to roll out a higher-throughput NovaSeq/S4 model toward the end of this year.

The market for NovaSeq should be very good. Illumina expects most of its HiSeq customers to migrate to the new system over the next few years. The flexibility and cost advantages of the NovaSeq system should also enable Illumina to win market share from rivals.

Perhaps the best thing about NovaSeq is that it could open up genomic sequencing to new customers. Labs that couldn't afford to do genomic sequencing in the past should be able to use NovaSeq to map human genomes affordably.

Demand

This expansion of the market is enormously important for Illumina. The more cost-effective the company can make genomic sequencing, the larger the customer base Illumina will have. And the more customers Illumina has, the more it will sell in consumables -- which comprise the bulk of the company's revenue.

Illumina projects that the NovaSeq architecture could ultimately lead to a $100 genome. If this goal is achieved, and there's no reason to think that it can't be, future demand for genomic sequencing should greatly exceed current demand.

At the same time, there is a global push for precision medicine, which involves tailoring medical treatment for patients' genetic profiles. Widespread adoption of precision medicine should drive demand even higher for Illumina's products.

Looking ahead

I don't think that Illumina's stock will muddle along like it's done in recent years for too much longer. The nice year-to-date jump in the company's share price reflects the promise of NovaSeq. As the new system rolls out, I expect Illumina stock to continue to rise.

There will be bumps in the road along the way, however. Illumina's management has warned about the potential for consumables revenue to be affected as customers transition to NovaSeq.

Because of this disruption, Illumina's stock performance in 2017 might be choppy. But it will only be temporary. Over the long run, this stock should return to its winning ways experienced before 2014. A solid business model, continued innovation, and rising demand point to even better days ahead for Illumina.

10 stocks we like better than Illumina
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Illumina wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of February 6, 2017

Keith Speights has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Illumina. The Motley Fool has a disclosure policy.