Metric loss

PacBio is (still) lagging behind on this crucial metric

Investing in lab equipment companies is easy.

That’s mainly because most genomics stocks from this niche industry don’t make the cut – at least when judged on a very important metric.

PacBio (PACB) is one of those companies.

Shares of the Menlo Park, Calif., company hit all-time highs during the 2021 liquidity bubble. A short squeeze and surge in meme stocks has helped lately.

Trading volumes in August have only been surpassed once in the company’s history – when it was the target of a takeover by fellow DNA sequencing peer, Illumina (ILMN) . (This agreement has not been concluded.)

But second-quarter 2022 operating results show the company still lags on the metric most important to investors.

Consume! Consume! Consume!

Labware business models are easy to understand and evaluate.

The most successful companies do not necessarily sell the most instruments, but rather sell the most chemicals and kits needed to operate the installed base of instruments. This is called consumable income. It represents recurring, wide-margin, high-volume revenue.

My more than a decade of investing and analyzing biotech stocks has taught me that labware companies face a tough climb. Typically, these stocks aren’t worth considering for your portfolio until two-thirds of the revenue comes 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. Not PacBio.

The DNA sequencing company generated 41% of total consumables revenue in Q2 2022, compared to 67% for investors. The company hasn’t topped 42% consumables in its revenue mix in the past two years.

Why should investors require consumables to be two-thirds of revenue? Consider two statistics from the second quarter of 2022:

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  • 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. This is well below its 10x peers Genomics, Illumina and Oxford Nanopore.
  • Scaling margins with revenue helps ease the pain further down the income statement. The company recorded an operating loss of $67.9 million and an operating cash outflow of $60.5 million. For comparison, the DNA sequencing platform only generated $35.5 million in revenue over the past three months.

Failure to grow consumables revenue and gross margin can limit flexibility when a labware business runs into difficulties. Like now.

A handful of lingering headwinds forced management to cut full-year 2022 revenue guidance. PacBio now expects revenue of approximately $141.5 million midway through this year, representing growth 8% year over year. That’s a slowdown from the 65% year-over-year growth achieved in 2021.

Can this DNA sequencing platform be on the right track?

The news for those long on stocks isn’t all negative.

PacBio ended June with $899 million in cash, which can fund about 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 prior year period. That’s a lot of potential future revenue on consumables.

But PacBio cited headwinds, including macroeconomic conditions such as pandemic shutdowns, inflation, a strong US dollar, supply chain issues and customers bracing for an upcoming economic downturn.

All of this can adversely affect utilization rates of the installed base of machines in customer labs. If the instruments are not used regularly, customers will place fewer consumable orders.

The stark reality is that PacBio is sandwiched between DNA sequencing peers Illumina and Oxford Nanopore, which are better positioned both from a technology perspective and revenue mix. Illumina continues to generate more than 70% of consumables revenue, while its third-generation counterpart, Oxford Nanopore, reached the magic level of 67% in Q2 2022.

The competitive landscape could pose medium to long-term competitive challenges for PacBio, especially given the inherent advantages and higher technical ceiling of nanopore sequencing.

Meanwhile, private peers such as Ultima Genomics and Element Biosciences are promising significant advancements in cost and data generation for their next-generation DNA sequencing platforms.

For now, and as long as an economic downturn looms, investors should remain realistic and cautious about PacBio.