I'm not confident the recent rally in the biotech sector can be trusted. I'm confident Twist Bioscience (NASDAQ: TWST) has significant valuation risk near current levels.

The DNA synthesis leader closed at $47.74 per share and a market cap of $2.7 billion on July 21. That could easily be cut in half by the end of 2022. Subscribers should be cautious heading into the fiscal third-quarter 2022 operating results announcement on Friday, August 5.

Why Twist Bioscience is Likely to Cough Up Its Premium

Wall Street has handed Twist Bioscience a significant premium during the biotech sector's correction. There are good reasons to do so.

There are other capable companies within the competitive landscape, including Integrated DNA Technology (IDT) and perhaps Codex DNA (formerly SGI-DNA). However, Twist Bioscience has advantages on cost, turnaround time, quality, and volume. That's pretty difficult to beat.

The DNA synthesis market's largest opportunities are also nearing commercialization. Target enrichment probes for next-generation sequencing (NGS) tools in liquid biopsy applications, such as minimal residual disease (MRD) detection in cancer monitoring and treatment optimization, represents a larger opportunity than the combined value of all markets currently being targeted. The potential to use synthetic DNA for archival data storage applications could be even larger.

Twist Bioscience also has an exceptional leader in co-founder and CEO Emily Leproust, who is one of the best leaders in the fledgling field of synthetic biology. The market trusts her decision making, vision, and execution. After all, the business' execution is easily visualized through its scale. Gross margin has steadily improved from 13% in fiscal 2019 to an expected 36% in fiscal 2022. It would've been even higher if not for the commissioning of a large manufacturing facility, and it was negative 315% in fiscal 2016.

Data Source: June 2022 investor presentation.

In other words, it makes sense for Twist Bioscience to be valued as a premium growth stock. Not many businesses deserve that title, although it was handed out like Halloween candy during the liquidity bubble of 2021. Even fewer businesses outside of software deserve it.

I'm not arguing against earning a premium. My problem is the size of the premium, especially in the context of the current macro environment. Let's be objective:

• Twist Bioscience expects fiscal full-year 2022 revenue of up to $199 million.
• The current market valuation is $2.7 billion.
• The current valuation multiple is 13x current-year sales.
• If the company grows revenue 40% to $280 million in fiscal 2023, then the current valuation multiple is 9.5x forward sales.

Investors could argue that's a little expensive for two reasons. First, a strong U.S. dollar could complicate things and force revenue guidance lower. In fiscal 2021, Twist Bioscience generated 59% of revenue from the Americas; 33% from Europe, the Middle East, and Africa (EMEA); and another 8% from the Asia Pacific (APAC). A strong U.S. dollar could slow or reverse revenue growth in international markets for the foreseeable future, or until central banks other than the U.S. Federal Reserve raise interest rates to remain competitive. They're unlikely to be as aggressive as ol' JPOW.

Second, the cash hungry business could report a fiscal 2022 operating loss of $245 million and a fiscal 2023 operating loss of at least $190 million, according to my models. Companies much closer to profitability have been whacked in the current selloff. None trade anywhere close to the premium Twist Bioscience enjoys.

What's an Attractive Entry?

The current risk/reward for Twist Bioscience is considered unfavorable overall due to valuation risk. This is considered an investment-grade Growth (Speculative) position, although I expect it to graduate to Growth (Quality) and perhaps even to Anchor over the course of this decade.

An attractive entry for Twist Bioscience is estimated at:

• Attractive valuation: $1.7 billion / ~$30.00 per share
• Consider prioritizing: <$1.4 billion / ~$25.00 per share
• Feel good adding up to: $2.0 billion / ~$35.50 per share

The valuation estimates above are based on 56.2 million shares outstanding as of May 4th, 2022. They account for the revaluation of the biotech sector and tightening financial conditions that began in early 2022. Investors are cautioned against using 2021 valuations as a benchmark or for comparison. Additionally, these estimates and suggested entry points are provided for investors with a long-term mindset, not traders.

Like it or not, Twist Bioscience is a trendy growth stock. That subjects it to more volatility until the rest of the liquidity bubble deflates – or until investors accept that we were and likely still are in a bubble. Subscribers are also cautioned to consider dilution risk, as the business will need to raise additional funding through public stock offerings in the next 24 to 36 months. A safe assumption is generally 15% dilution per equity raise. I've added that into the entry points above to provide a better margin of safety.

Ol' Maxxie's Position

Twist Bioscience has a target allocation of 3% in my personal portfolio. I have not reached this target, as I only started a position in May 2022. I calculate target allocations based on total principal put into my portfolio.

I wouldn't be surprised to see Twist Bioscience dip below $25 per share by the end of 2022. This may come down to the influence of the strong U.S. dollar, which investors will learn more about on the upcoming fiscal third-quarter 2022 operating results announcement on Friday, August 5. It's also possible I'm discounting the near-term potential of the biopharma operations, although I'm fairly confident those will take a few more years to make meaningful contributions.

Further Reading

• June 2022 investor presentation
• Fiscal second-quarter 2022 earnings press release (May 5, 2022)

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