Shares of investor favorite Twist Bioscience (TWST) – Get the report from Twist Bioscience Corporation decreased by 43% from the beginning of the year until the end of July. They could still be overvalued.
The company, a leader in DNA synthesis for biotech researchers, deserves to trade at a premium. The current premium amount may be questionable.
If the company has revenue of $200 million in fiscal 2022, the current market capitalization would equate to a valuation of 12.3 times sales.
If the company meets the Wall Street consensus’s fiscal year 2023 revenue expectation of $260 million, then shares are currently trading at 9.5 times forward sales.
Both are a bit rich, especially for a company expected to post a record operating loss in fiscal 2022 and with a historically strong US dollar. Investors should be prepared for all the results ahead of the third quarter 2022 financial results which are expected to be released on August 5.
What does Twist Bioscience do?
Twist Bioscience is a leader in DNA synthesis. While DNA sequencing is the act of reading the genetic code, DNA synthesis is the act of writing the genetic code. Creating synthetic genes facilitates everything from engineering microbes to producing polymers for foldable smartphone screens to precision liquid biopsy tools. In the not-too-distant future, synthetic DNA could even be used for long-term storage of digital data from clients such as Microsoft. (MSFT) – Get the Microsoft Corporation report and Netflix (NFLX) – Get the Netflix Inc.. It’s a pretty sweet niche.
There are other companies in the competitive landscape, including Genscript Technology and Integrated DNA Technologies IDT, both of which are privately held. These peers have a better quality control track record, which is critically important. However, the cost advantages of Twist Bioscience’s platform have allowed it to carve out a significant market share – for now, at least.
Twist Bioscience’s rapid rise has caught the attention of investors. The company increased its revenue from just $2 million in 2016 to $132 million in 2021. Sales are expected to climb to nearly $200 million in fiscal 2022. Above all, the company has benefited from its size. Gross margin has grown from minus 315% in 2016 to over 39% in 2021. This may be taken for granted in software companies, but it doesn’t always materialize in companies offering physical products. It’s truly impressive, earning the company a well-deserved bonus.
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However, gravity could prove to be the strongest force over the next 12 months.
What’s in the third quarter fiscal 2022 results?
Twist Bioscience faces multiple headwinds in the second half of the 2022 calendar.
First, a strong US dollar could undermine trade momentum. The leader in DNA synthesis generated 41% of total revenue outside the Americas in fiscal year 2021. Fellow growth darling 10x Genomics (TXG) – Get the 10x Genomics Inc. generated 47% of its revenue from international customers last year. He recently prepared investors for a decline in year-over-year earnings in the second quarter of 2022, largely due to a strong greenback. This could cause problems for Twist Bioscience.
Second, a large group of customers face their own headwinds. Twist Bioscience generates 55% of its revenue from Next Generation Sequencing (NGS) tools. There’s a certain irony in writing DNA to make it easier to read DNA, but genetic testing and liquid biopsy tools need to compare patient samples to accurate templates. Synthetic DNA can be used to provide the templates, called reference probes by nerds in lab coats. Unfortunately, customers like Invitae (NVTA) – Get the Invitee Corporation report have significantly reduced their own growth expectations in recent weeks, while regulatory delays and lack of commercial traction could push some orders from other customers into fiscal 2023 or later.
Third, equities oddly escaped the worst of the biotech correction. Investors may scoff at this notion given that the growth stock is down 43% since the start of 2022, but Twist Bioscience shares are trading at a considerable premium to the underlying business.
Wall Street appears to be pricing the premium on sales growth, which has been relatively impressive. Revenue for fiscal 2022 is expected to increase nearly 47% over the prior year period. Fiscal 2023 sales are expected to increase nearly 40%. This can be a little generous for some of the reasons stated above.
Additionally, Twist Bioscience is far from profitable and will remain a cash-hungry business for the next few years. The DNA synthesis leader is likely to report an operating loss of $245 million according to my models, which would be an all-time high. In fact, that would be almost 60% more than last year’s all-time high.
To be fair, the company ended March 2022 with $609 million in cash, but it will likely take more over the next 24-36 months to sustain growth investments. Future stock dilution may not provide an attractive margin of safety near the current stock price.
Hope for the best, prepare for less
Twist Bioscience is expected to remain a premium growth stock for years to come. It has earned a place in my personal portfolio, albeit at a relatively small allocation. Nonetheless, investors need to maintain valuation discipline, especially as financial conditions tighten. That suggests investors should be cautious heading into the third quarter 2022 earnings reading in August.