Investing in lab-hardware companies is easy.
That's primarily because most genomics stocks hailing from this niche industry don't make the cut -- at least when judged on one all-important metric.
PacBio (PACB) is one of those companies.
The Menlo Park, Calif., company's stock rose to all-time highs during the liquidity bubble of 2021. A short squeeze and meme-stock boost have helped lately.
Trading volumes this August have been topped only once before in the company's history -- when it was the target of a takeover by fellow DNA sequencing peer Illumina (ILMN). (That deal didn't close.)
But second-quarter 2022 operating results show the business still lags on the most important metric for investors.
Consume! Consume! Consume!
Lab-hardware business models are easy to understand and gauge.
The most successful companies don't necessarily sell the most instruments, but instead sell the most chemicals and kits needed to operate the installed base of instruments. This is called consumables revenue. It represents recurring, wide-margin, and high-volume revenue.
My decade-plus of investing and analyzing biotech stocks has taught me that lab hardware companies face an uphill climb. As a simple rule of thumb, these stocks don't warrant consideration for your portfolio until two-thirds of revenue is generated from consumables.
Few companies make the cut. 10x Genomics (TXG), Illumina, and Oxford Nanopore (ONTTF) are among the few companies that meet or exceed this mark. PacBio does not.
The DNA-sequencing company generated 41% of total revenue from consumables in Q2 2022, compared with the 67% level investors should look for. The company hasn't topped 42% consumables in its revenue mix in the past two years.
Why should investors demand that consumables account for two-thirds of revenue? Consider two stats from Q2 2022:
- Consumables revenue is wide-margin. PacBio delivered a gross margin of 45.7%, just a tick higher than the 45.1% margin generated in all of 2021. That's well below peers 10x Genomics, Illumina, and Oxford Nanopore.
- Scaling margins with revenue helps alleviate pain further down the income statement. The business reported an operating loss of $67.9 million and operating-cash outflow of $60.5 million. For comparison, the DNA-sequencing platform generated only $35.5 million in revenue during the most recent three-month period.
Failing to grow consumables revenue and gross margin can limit flexibility when a lab-hardware business encounters challenges. Like right now.
A handful of persistent headwinds forced management to reduce full-year 2022 revenue guidance. PacBio now expects revenue of about $141.5 million at the midpoint this year, representing year-over-year growth of 8%. That's a slowdown from the 65% year-over-year growth achieved in 2021.
Can This DNA Sequencing Platform Get On Track?
The news for those who go long stocks is not all negative.
PacBio ended June with $899 million in cash, which can fund roughly three years of operations at the current rate of cash burn.
Additionally, the company reported an installed base of 460 instruments at the end of Q2 2022, up 63% from 282 at the end of the year-earlier period. That represents a lot of future potential consumables revenue.
But PacBio cited headwinds including macroeconomic conditions such as pandemic lockdowns, inflation, a strong U.S. dollar, supply-chain issues, and customers hunkering down for a coming economic slowdown.
Any and all of those can hurt utilization rates for the installed base of machines in customers' laboratories. If the instruments aren't being used consistently, customers will place fewer orders for consumables.
The blunt reality is PacBio is sandwiched between DNA-sequencing peers Illumina and Oxford Nanopore, which are better positioned from both a technology and revenue-mix standpoint. Illumina continues to generate over 70% of revenue from consumables, while third-generation peer Oxford Nanopore hit the magical 67% level in Q2 2022.
The competitive landscape could pose mid- and long-term competitive challenges for PacBio, especially considering the inherent advantages and higher technical ceiling of nanopore sequencing.
Meanwhile, privately held peers such as Ultima Genomics and Element Biosciences promise significant advances in cost and data generation for their next-generation DNA-sequencing platforms.
For now, and so long as an economic slowdown remains on the horizon, investors should remain realistic and cautious when it comes to PacBio.
