One Company That's Set to Win From Precision Medicine

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In the last few decades, incredible strides have been made in genome typing and precision medicine technology. What used to cost hundreds of thousands of dollars is now available for $100, opening up the biotech world to tons of new research and treatment opportunities. But the vast majority of clinical trials fail, and biotechs are very risky investments.

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In this clip from Industry Focus: Healthcare, host Kristine Harjes and contributor Todd Campbell explain why most of the precision medicine space is risky for investors, and how Illumina (NASDAQ: ILMN) is one company that gets exposure to the industry without taking on that astronomically high failure risk.

A full transcript follows the video.

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This video was recorded on Aug. 9, 2017.

Kristine Harjes: All right, Todd, time to talk about precision medicine and a potential picks and shovels way to play on that market.

Todd Campbell: This is an amazing and fast-moving opportunity that investors have to do some research on and become a little bit aware of. The reality is, as technologies are advancing, we're learning more and more about how the body works, what drugs work in the body to help improve outcomes for illness and injury, and as a result, there's a tremendous market opportunity out there for targeting medications, precision medicine, or personal medicine, they all mean the same thing.

Harjes: Yeah. As we learn more and more about DNA and how the makeup of your DNA influences your health outcomes, you get more and more tailored healthcare products and drugs that can improve your medical issues specifically based on what your body has to say. I almost think of this as, you're mining for information in the same way that the Gold Rush miners were mining for gold. You're digging into the body and all of the hidden things that DNA has to tell you, and you're extracting information. There's so many researchers out there looking into the implications for medicine and how we can better tailor it to a unique situation.

Campbell: Kristine, and digging into that DNA can produce billions and billions of dollars in revenue for companies that develop drugs based on whatever it is that they're learning. We're already seeing that. We have $300 billion a year that are being spent on prescription medications in the United States alone, and you have over $100 billion being spent on specialty medicines that are complex biologics that theoretically will get even more and more complex as we learn more and more about how genes overexpress and underexpress to create proteins that impact cellular functions.

Harjes: Yeah. You and I are both big fans of investing in these drug makers. We talk about them all the time on this program. But the picks and shovels way to play this is not in the drug makers themselves, but rather a company that we also have talked about on the show that does the sequencing on the DNA itself. This company is Illumina.

Campbell: Right. I think one of the things we've talked about in past on the show, I always like to hammer this point home because we never know if we have a new listener, is the fact that so many clinical trials fail. Over 90% of clinical cancer trials have come up short. What that means is, if you're going out and you're trying to pick that one individual company that's going to be the success story in personal medicine, well, the odds are stacked against you. Instead, it can be smarter, perhaps, to focus on a pick and shovel play like Illumina, because they're selling the systems that all of these researchers and all of these commercial drug makers and biotechnology companies are using to learn more about DNA and RNA and the impact of over and underexpression on disease.

Harjes: And importantly, Illumina has been able to bring down the cost of doing so to a degree that is unfathomable. When you look at the cost of the first-ever genome sequence, it was maybe $1 million, ballpark around there. It was very expensive to just get a single genome sequenced.

Campbell: And it took forever.

Harjes: Yeah, absolutely. This was this enormous endeavor to do the very first one. And Illumina has been working and working on bringing that cost down, making it a more efficient process. Their newest sequencing machine, called NovaSeq, could potentially bring the cost of a single genome sequence down to $100, which is absolutely mind-blowing. And that opens up so many possibilities, not just for researchers and not just for drug makers, but even for doctors, to be able to causally order a genetic sequence for their patients in order to find out the exact biomarkers of a cancer tumor, or any other number of countless things that you can find out from sequencing DNA in order to get the best personalized treatment.

Campbell: Yeah. We are complex creatures, and these are complex machines. And they're costly machines. These machines can cause $0.5 million to $1 million and more. And so far, there are other competitors out there that make gene sequencing systems, but Illumina is the granddaddy and it's the Goliath. It has over 7,500 of these systems spread out across the world. It gets a little bit more than 40% of its sales outside of the United States. So, it doesn't matter if you're talking about a researcher that's in Shanghai or a researcher that's in London, or a researcher that happens to be in Cambridge or San Francisco, they're most likely using an Illumina machine. And if they're using an Illumina machine, then not only did they buy the Illumina machine, but they're consistently buying all the other consumables that are used by these machines to do all of the sequencing. And that's why the reducing of the price to gene sequencing is such a good thing for Illumina's long-term story. Now, we're talking about, cheaper to sequence means more sequencing activity, which means more demand for those consumables.

Harjes: Yeah. This company is not only picks and shovels, it's also razor and blades model, which is something, as investors, we love. We love to see that consistent, steady income coming from the consumables.

Campbell: Yeah, absolutely. And they represent a large share of the company's sales. I think it's 61% in the most recent quarter came from that razor blade consumables side of the business. I think you're going to see the mix shift a little bit as this next new generation of machines, more of those get installed and sold, because they have lower margins. So, you may go through a little bit of growing pains in terms of earnings that might not grow quite as quickly, because the margins may slip a little bit because of product mix. Don't worry about that. Don't focus on the quarter-to-quarter machinations in this. You're still talking about a massive opportunity, double-digit grower, profitable company with deep pockets that's an innovator and at the cutting edge of this technology.

Harjes: Yeah. I do think some investors are a little bit concerned that the cheaper machines are going to cannibalize sales of the more expensive machines. But the way that I see it, one third of new orders for the NovaSeq machines have come from new customers, because it's a cheaper machine that brings the per genome sequence cost down as well. So, they're able to reach people who previously wouldn't be willing to spend this money to do their research or treat their patients. This company, as you mentioned, it does have a big growth trajectory in front of it. You have to think about long-term, because it's pretty darn expensive, as well. I don't have the multiples in front of me, but it is traditionally an extremely expensive company. And that's because it does seem like they're just getting started, and this entire wave of precision medicine is something that's very early going.

Campbell: Yeah. I've heard some people say, "At some point, won't all the genomes be discovered? Won't all this research have been done? What will demand feel like long-term for these machines?" So, maybe you reach a point where there's a little bit of a tipping point where you have all of the machines installed everywhere, and maybe you have so much information that the pace of research slows a little bit. But you have to understand that this company isn't ignorant to that fact. They're already making some pretty big investments in the ways that this information can get used longer-term, that will diversify their revenue stream theoretically a little bit away from the systems. Again, we're talking about a multi-decade shift in this business. This is not something that's happening in a year or two. But the two different businesses that I think are most interesting for investors to take a look at are Grail and Helix, both of which Illumina owns a big stake in, and both of which are looking at new and unique ways of using all the genetic information we're developing.

Harjes: Yeah. Both of these, as you mentioned, are definitely long-term plays. They're doing revolutionary things. And you're right, even if the core business were to eventually hit a tipping point, it's entirely likely that at that point, it wouldn't matter, because Grail and Helix will hopefully have panned out by then.

Campbell: Yeah. And there's opportunities, obviously, to team up with these drug makers and take a small share in royalties, or who knows what, of sales further on based on whatever they've discovered. Grail is looking for early detection of cancer. Imagine being able to detect cancer at stage 1.

Harjes: Before you even show symptoms.

Campbell: Right, exactly. Cancer is so much more easily treated when it's caught early. The earlier that we can catch it the better. If Grail is able to do that, wow, that could be a huge driver for Illumina long-term -- again, multi-decade, looking further and further out. Helix is also intriguing, because you're talking about a warehouse that can store all of your genetic information and an app store that you can go out and be able to purchase different apps to learn more about your genetic code. So, there's different interesting ways that I think Illumina can benefit from this whole move toward personalized medicine. And it's a great pick and shovel type play on precision medicine.

Kristine Harjes has no position in any stocks mentioned. Todd Campbell has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Illumina. The Motley Fool has a disclosure policy.