On Wednesday, July 23, Illumina reported second-quarter earnings that were well above expectations, primarily driven by strong instrument shipments across all sequencing platforms (primarily NextSeq, and HiSeq X Ten but also strength in existing platforms MiSeq and HiSeq 2500). Revenue of $448 million was above our and Street consensus estimate of $427 million. EPS of $0.57 beat our estimate of $0.51 and consensus at $0.50; EPS benefited from a lower effective tax rate and higher gross margins than we had forecast.
We were impressed by the continued lack of cannibalization for the older instrument systems from new machines introduced earlier this year, which suggests the company’s product segmentation strategy has been successful, as well as the number of new instrument buyers of existing platforms in the quarter (70% of MiSeq orders were from new customers). This supports an expanding market. Management updated 2014 guidance to revenue growth of 25% to 26% and adjusted EPS of $2.26 to $2.28, up from 21% to 23% and $2.10 to $2.15, respectively (we had projected revenue growth of 23% and EPS of $2.15).
Implied revenue growth in the second half of the year is 24% compared with 28% in the first half. We now project revenue growth of 26% ($1,789 million) and adjusted EPS of $2.28 (27% growth). As of the markets close on Wednesday, July 23, Illumina’s stock is at $180.64 (although is indicated up about 2% to 3%), compared with its 52-week high of $184.49 reached on July 2. The stock is trading at 13.0 times 2015 revenue and 65.5 times on a price-to-earnings basis on 2015, which is well above the average of 6.0 times revenue and 38.0 times price-to-earnings. The company is the clear leader in a massive market (with a well-defined $20 billion total addressable market) and recent results point to meaningful demand across the company’s full suite of products; therefore, we maintain our Outperform rating.
Assuming Illumina can secure half of its $20 billion total addressable market over five years discounted back (at 15%) and using a 5-times enterprise value-to-sales multiple suggests a fair value of $200. Our discounted cash flow also supports a valuation of $200 (assumes 30% over the next couple of years and 20% for the remaining 10-year period—3% terminal with margin expansion). While the company could not be better positioned fundamentally, we would continue to wait for marketrelated pull backs to accumulate shares, given what we believe are high expectations built into the name.