Biotech stocks are mired in a historic correction. That's not news. What doesn't receive much discussion is that the correction was largely justified and long overdue.
Throughout 2020 and 2021 investors were bombarded with hype from trendy thematic exchange-traded funds and short-lived social-media celebrities. Couple that with share prices that seemed to move only in one direction and a human brain wired for confirmation bias, and it became easy to think, "this time really might be different."
It wasn't. The correction shows that fundamentals still matter, drug development is difficult, and biotech is not tech.
It's significantly more difficult for a drug developer to earn a market valuation of $10 billion compared with a software business. Valuations might soar far above prices suggested by fundamentals, but derisking events – development, regulatory, and commercial milestones – are what ultimately determine prices.
While some corrected biotech stocks are merely closer to fair value, others are now beginning to look attractive for investors with a long-term mindset.
10x Genomics (TXG) is a quality growth stock that investors might want to become more familiar with as the macro environment takes a turn for the worse.
What Does 10x Genomics Do?
10x Genomics is a lab-hardware provider that helps customers better understand the complexity of biology. It sells instruments and the disposable products required to run them that enable scientists to visualize biology in resolution ranging from single cells to systems of millions of cells.
The company's Chromium and Visium products have become integrated into drug-development workflows worldwide. In fact, the business counts all the top 100 global research institutions and all the top 20 global biotech companies as customers.
Consumables Rule Everything Around Me
What makes 10x Genomics a quality growth stock is its revenue mix.
It may be known for selling lab instruments, but the primary source of revenue and profit actually is sales of the disposable reagents needed to operate them. Think of it like a printer-and-ink or razor-and-blade business model. This revenue category, called consumables, is what separates premium-lab-hardware businesses from the also-rans.
Take DNA sequencing leader Illumina (ILMN) as the perfect illustration. Investors may be most familiar with the sequencing instruments it sells to customers across the globe, but the business generated 81% of revenue from consumables in 2021. Illumina is basically a chemicals supplier.
Revenue mix is among the first metrics investors should consult when researching a lab-hardware company. Most don't make the cut. Pacific Biosciences of California (PACB) generates only 40% of revenue from consumables. It reported an operating loss of $210 million for 2021. NanoString Technologies (NSTG) generates 53% of revenue from consumables. It reported an operating loss of $108 million for 2021.
Now consider 10x Genomics, which generated 85% of revenue from consumables in 2021. It reported an operating loss of $52 million for last year, but the deficit stemmed primarily from continued investments in growth. The business generates almost as much revenue every quarter as PacBio or NanoString generates in a year.
Investors will be reassured that 10x Genomics had a cash balance of $539 million at the end of March 2022 and will burn less than $100 million this year. It likely could be profitable if the macro environment demanded hunkering down – or continue investing in growth as competitors pull back.
Why Is 10x Genomics Attractive?
To be blunt, shares of 10x Genomics were swept up in the wild speculation of 2021.
At its peak the business was valued at nearly $20 billion and over 40 times sales, which was ridiculous. As a general reference, the best-of-the-best lab-hardware and medical-device companies tend to max out at around 15 times sales – and even that should raise some eyebrows.
The business is valued at roughly $5.5 billion and 9 times projected 2022 revenue roughly six months into the biotech correction. The shares can always head lower, especially considering that the stock market could fall further in the next 12 to 24 months.
But investors cannot be concerned about calling a bottom. Instead, investors should be concerned only about maintaining valuation discipline and investing in attractive opportunities.
After multiple years of trading at a silly valuation, shares of 10x Genomics finally deserve a little more attention from investors with a long-term mindset.
