Is Fulgent Genetics Stock More Than a One-Hit Wonder?

Our MBAs at Nanalyze are constantly tweaking our disruptive tech investing methodology, adapting our metrics as we play through one of the weirdest post-bull runs in Wall Street history – and that’s saying a lot. Gone are the days of growth at all costs, but that’s been the mantra of the tech sector for a long time now, so it will take some effort to turn that ship around. In the meantime, we’re looking for other ways to assess the health and long-term outlook for disruptive tech stocks. One metric is to check out gross margins, which represent total sales revenue minus how much it costs to produce the goods or services for the marketplace. Bigger is better, because the larger the gross profit, the more likely a company can become consistently profitable without relying on debt or diluting shareholder value. 

A relatively thin gross margin is one reason Invitae (NVTA) stock is dropping like a rock. A genetics testing company that not too long ago was a rapidly rising star in the industry, Invitae surpassed a much larger rival in just a few years. Now, saddled with debt, Invitae will likely have to raise more capital to survive over the next few years. In November 2021, when we last covered the company, it had a market cap of $4.5 billion. Today, it’s valued at less than $1 billion. While we still believe genetics sequencing and testing, as well as related areas like proteomics, are disruptive technologies with high investment potential, the current fiscal climate is showing us the duds from the studs among the life sciences landscape. 

So what to make of a genetics testing company called Fulgent Genetics (FLGT) that has grown revenues like crazy, is profitable, largely debt-free, and enjoying much higher gross margins than Invitae?

About Fulgent Genetics Stock

One word: Rona. The pandemic made winners out of wannabes. Call it the Zoom effect. During 2020 and 2021, investors went all-in on stocks that seemed best positioned to take advantage of a socially distant world, from telehealth darlings like Teladoc to Zoom itself and its remote connectivity platform. Another category of winners involved companies that specifically pivoted products and services to capitalize on the virus. That’s where Fulgent Genetics falls. 

Founded more than a decade ago, Fulgent Genetics is based out of the Los Angeles area and had reportedly raised about $35 million before going public in September 2016. It raised a similar amount at the time to help commercialize its platform for predicting and detecting diseases, including cancer, using various genetics technologies. In 2019, the company had a modest $32.5 million in revenue but had nearly broken even for the year. Then came SARS-CoV-2 and a hard pivot into developing and selling genetics-based tests to detect the disease covid-19. Revenue spiked to more than $421 million in 2020 and then to nearly $1 billion in 2021. Between March 2020 and December 2021, the volume of tests Fulgent performed on a daily basis increased by approximately 14,800%. In 2021 alone, the company recorded 10 million billable tests, which represents more than 70% of all the billable tests it has done since 2013.

The good times continued into the first quarter of this year, thanks to the highly contagious omicron variant. Since then, however, coronavirus testing has fallen off a cliff because … well, whatever … but the point is that covid cash cow is starting to bleed out. Check out Q2-2022 revenues compared to the previous three quarters, especially Q1-2022.

Fulgent had about $320 million in revenue in Q1-2022, with $295 million from COVID-19 testing, which means more than 90% of its revenues were linked to the Rona. In addition, Los Angeles county accounted for more than a quarter of all revenues for all of 2021. 

Covid Vs Fulgent’s Core Business

Normally, that would be enough for us to call the case closed and wrap up this article with a wag of our finger. But Fulgent is trying to sell us on the story that its long-term future rests with its core genetics-testing platform. Maybe. In the most recent Q2-2022, the company tested its way to $125 million in revenue, down from $154 million in Q2-2021. The split was $80 million covid/$45 other testing, which comes out to a 64%/$36% split. In Q3-2022, Fulgent expects its core next-generation sequence (NGS) testing to account for more than half of all revenues for the first time since March 2020, breaking down into $54 million in core revenue and $51 million in covid testing.

The revenue numbers are trending in the right direction, if we’re worried about Fulgent being just a one-hit covid wonder. So let’s briefly take a look at the company’s technology platform, since that’s what we would actually be investing in.

The Fulgent Genetics Platform

The technology platform from Fulgent Genetics is based on its own proprietary gene probes, which uses DNA or RNA fragments to detect a target sequence of DNA in a sample, such as the Rona virus. The company combines these gene probes with its proprietary genetic reference library of genetic variants and publicly available genetic databases to offer a wide menu of tests. In addition, these customized gene probes “are specifically engineered to generate genetic data optimized” for the company’s specialized software, which enables it “to rapidly incorporate new genes into our test menu, develop new panels of disease-specific tests and customize tests for our customer.”

So what does Fulgent test for aside from covid? It has a couple of hereditary oncology test panels, with the VIP version screening up to 127 genes. Another hereditary test panel, Beacon, screens for more than 400 rare inherited conditions. There is also a newborn genetic test service that checks for more than 200 disorders where early detection could help improve infant health and quality of life, according to the website PR. A new test branded under HelioLiver requires a simple blood draw to detect liver cancer in adults deemed high risk due to cirrhosis of the liver. However, while Fulgent also offers diagnostic tests for cancer and recently rolled out one for monkeypox, most of its current capabilities are prognostic.

Fulgent’s Acquisitions and Joint Venture

But that’s changing, thanks to a couple of recent acquisitions.

In August 2021, Fulgent acquired CSI Laboratories, which specializes in cancer diagnostics, including the gene mutations generally responsible for tumors. Genetic tumor screening looks for these abnormalities to help doctors figure out the best course of treatment. It’s another play on precision medicine and the ability to individualize care. Earlier this year, Fulgent also acquired Texas-based Inform Diagnostics, a private nationwide pathology laboratory, for $170 million. From the PR, it sounds like this deal helps Fulgent expand its genetic testing into new U.S. markets, and is less about the technology, in contrast with CSI. Throw in a joint venture in China to sell genetics tests to a new market and a Series A investment in a startup developing even fancier genomic tools, and you see a company executing on a post-covid strategy.

Should You Buy Fulgent Genetics Stock?

We’re not sold on Fulgent Genetics Stock but certainly intrigued. The company is projecting $665 million in revenue for the year, with covid still accounting for 72%. Still, that’s $185 million in non-covid revenue for a genetics testing company that broke even at $32.5 million just three years ago. At the company’s current market value of $1.35 billion, $185 million alone results in a simple valuation ratio (market cap/annualized revenues) of about 7 – where 40 is considered too rich for our blood. 

It’s unclear how big the total addressable market (TAM) is, but let’s use Medicare as a proxy. It accounts for about 20% of $4 trillion in healthcare costs in the United States. Between 2016 and 2019, the number of genetic-testing procedure codes Medicare covered increased by 161%, while the number of genetic tests Medicare paid for increased by 230%. In dollars, that’s $1.4 billion by 2019. If Medicare accounts for $1 in every $5 spent on U.S. healthcare, that’s $7 billion spent annually on genetics testing. (Aside from the JV, Fulgent is focused on the U.S. market currently.) Illumina, which provides the NGS machines that Fulgent uses for its platform, made $4.5 billion in revenue last year – more than half of our very rough estimate of the TAM for genetics testing. 

In other words, Fulgent competes in a fast-growing but still-modest market, going up against the likes of Myriad Genetics and Invitae, which together made more than $1 billion in revenue last year. Still, it’s hard not to feel that Fulgent is on the rise, like Invitae once was. Remember, gross margin? Fulgent’s gross margin was 52.1% in its most recent quarter, down significantly from its covid heyday by more than 20 points, and more in line with 50% during pre-covid 2019. At last glance, Invitae was at just 21%. Fulgent has a lot more cushion for pushing its way up the leaderboard for genetics testing.

Conclusion

Fulgent certainly milked the covid cash cow when it could, building up a nice stash of cash to help fuel its recent growth on its terms and without additional debt. It’s a very different story than Invitae, but Fulgent must still prove it won’t end up like 70% of lottery owners and be broke in seven years. It also must prove it can integrate these new businesses, which are already adding to its bottom line, as well as break into overseas markets. We’ll see how that China JV works out. Presumably, there were a few lessons learned from scaling up for covid that the company can apply as it grows its genetics-testing platform into new markets.

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