Should Twist Bioscience Investors Prepare for Disappointment?

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Shares of investor favorite Twist Bioscience  (TWST) – Get Twist Bioscience Corporation Report have declined 43% since the beginning of the year through the end of July. They still might be overvalued.

The company, a leader in DNA synthesis for biotech researchers, deserves to trade at a premium. The size of the current premium may be questionable.

If the business achieves fiscal full-year 2022 revenue of $200 million, then the current market cap would equate to a valuation of 12.3 times sales.

If the business meets Wall Street’s consensus fiscal full-year 2023 revenue expectations of $260 million, then shares are currently trading hands at 9.5 times forward sales.

Both are a little rich, especially for a business expected to deliver a record operating loss in fiscal 2022 and with a historically strong U.S. dollar. Investors need to prepare for all outcomes ahead of fiscal Q3 2022 financial results scheduled to be released Aug. 5.

What Does Twist Bioscience Do?

Twist Bioscience is a leader in DNA synthesis. Whereas DNA sequencing is the act of reading the genetic code, DNA synthesis is the act of writing the genetic code. Creating synthetic genes aids everything from engineering microbes to produce polymers for foldable smartphone displays to ensuring the accuracy of liquid biopsy tools. In the not-too-distant future, synthetic DNA may even be used for long-term storage of digital data from customers such as Microsoft  (MSFT) – Get Microsoft Corporation Report and Netflix  (NFLX) – Get Netflix Inc. Report. 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 track record when it comes to quality control, which is critically important. However, the cost advantages of Twist Bioscience’s platform have allowed it to elbow its way to significant market share – for now, at least.

The rapid ascendance of Twist Bioscience has caught the attention of investors. The business has grown revenue from just $2 million in 2016 to $132 million in 2021. Sales are expected to climb to nearly $200 million in fiscal 2022. Importantly, the business has benefited from its scale. Gross margin has improved from negative 315% in 2016 to positive 39% in 2021. That may be taken for granted in software businesses, but it doesn’t always materialize in businesses with physical products. It’s truly impressive, which has earned the company a much-deserved premium.

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However, gravity may prove to be the stronger force in the next 12 months.

What’s On Tap in Fiscal Q3 2022 Earnings?

Twist Bioscience faces multiple headwinds in the second half of calendar 2022.

First, a strong U.S. dollar could chip away at business momentum. The DNA synthesis leader generated 41% of total revenue from outside the Americas in fiscal 2021. Fellow growth darling 10x Genomics  (TXG) – Get 10x Genomics Inc. Report generated 47% of revenue from international customers last year. It recently prepared investors for declining year-over-year revenue in Q2 2022 due in large part to a strong greenback. That could spell trouble for Twist Bioscience.

Second, an important group of customers is facing its own headwinds. Twist Bioscience generates 55% of its revenue from next-generation sequencing (NGS) tools. There’s some irony to writing DNA to help the reading of DNA, but genetic tests and liquid biopsy tools need to compare patient samples to accurate templates. Synthetic DNA can be used to provide the templates, referred to as reference probes by nerds in lab coats. Unfortunately, customers such as Invitae  (NVTA) – Get Invitae Corporation Report have greatly 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, shares have curiously escaped the worst of the biotech correction. Investors may scoff at that notion considering the growth stock is down 43% since the beginning of 2022, but shares of Twist Bioscience trade at a considerable premium relative to the underlying business.

Wall Street seems to be staking the premium to sales growth, which has been relatively impressive. Fiscal 2022 revenue is expected to grow nearly 47% compared to the year-ago period. Sales in fiscal 2023 are expected to grow almost 40%. That may be a little generous for some of the reasons stated above.

Additionally, Twist Bioscience is far from profitability 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 nearly 60% higher than the all-time high set last year.

To be fair, the business ended March 2022 with $609 million in cash, but will surely need more in the next 24 to 36 months to maintain growth investments. The upcoming share dilution may not provide an attractive margin of safety near the current share price.

Hope for the Best, Prepare for Less

Twist Bioscience is likely 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 fiscal Q3 2022 earnings readout in August.