The Foster City, Calif.–based biotech company, with a $115 billion market cap, faces legitimate issues, but the stock probably discounts most, if not all, of these challenges. One or two positive surprises could ignite a solid rally in Gilead’s shares.
Gilead has suffered from the market’s disaffection for biotechs in general. In particular, investors worry that—with Gilead’s important hep-C product priced around $1,000 per pill—the next administration might force drug prices down. Yet its hep-C products, such as Solvadi and Harvoni, cure the disease after a few months treatment, which should mitigate regulatory price pressures. In the long run, it’s cheaper.
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Ironically, another fear is that Gilead will run out of hepatitis patients and hep-C sales will fade, one of the more overblown challenges. Ending hepatitis is a desirable goal, but on a global basis that’s likely to come many years down the line. Gilead’s hep-C sales last year were about $19 billion. They are likely to drop a bit this year, as competition increases.
Additionally, Gilead missed analyst consensus earnings-per-share estimates in a messy first quarter, and initially lost a court decision in March when a jury ruled for Merck in a patent suit against Gilead, assessing $200 million in damages. Yet a judge voided that decision last month.
In the first quarter, sales rose to $7.7 billion, with $3.6 billion in net income, or $2.53 per share, in diluted EPS. That compares with $7.4 billion, and $4.3 billion, or $2.76, respectively, in the first quarter of 2015. Quarterly profits were hurt by legal fees. Guidance for 2016 is $30 billion to $31 billion in sales, down from $32.6 billion in 2015 but up from $25 billion in 2014.
Another issue, notes Henry Smith, a portfolio manager at Haverford Trust, is that patents on some of its HIV treatments, with $10 billion in annual sales, expire from 2018 to 2021. Gilead’s antiviral products, which include drugs targeted at the liver and HIV, make up the vast majority of total sales.
Nevertheless, Haverford bought Gilead shares during the February market correction and again lately, Smith says. The stock price gives the company “zero credit” for its $3 billion in annual research-and-development spending, some 60 Phase 3 clinical trials, and a track record of smart acquisitions. Gilead has plenty of ammunition for the last—$21 billion in cash, or about $16 per share.
Things are not as dire as the bears would have it, and Gilead’s pipeline isn’t as weak as they contend. Earlier this month, Gilead received European approvals for its new hep-C product, Epclusa. In June, it was approved in the U.S. While some fret about potential hep-C price cuts, Gilead has been taking middle-single-digit percentage price increases elsewhere.
While these worries shouldn’t be ignored, if just one or two of these head winds falls away, the stock could rise about 25% over the next two years. If nothing improves, the downside appears limited, as Gilead has the wherewithal to make acquisitions; increase the dividend, now yielding 2.2%; and buy back shares.
Smith ticks off four potential catalysts: “If hep-C sales prove more durable than expected; HIV treatments continue to grow; R&D is a little more productive than zero; and Gilead makes a successful acquisition.” Any one of these would raise its remarkably low price/earnings ratio, he says.
The stock trades at seven times 2017 analyst consensus EPS estimates of $12.32, compared with an expected $12 EPS this year. That P/E is half of both Gilead’s average P/E and its peers’ P/E. Moreover, it is at the biggest discount to the market P/E in Gilead’s history.
Another Gilead bull, Dr. Mark Schoenebaum, an analyst with Evercore ISI, recently told clients that in his base case, assuming declining hep-C sales and an HIV-sales fade in 2018, Gilead will still be able to generate free cash flow about equal to its enterprise value ($117.5 billion) over the next eight years or so.
And if none of Smith’s catalysts happen? “You have a company buying back lots of its stock, $8 billion worth in the first quarter.” There could be as much as a 40% reduction in the share count over the next few years, he adds.
Share repurchases can be a poor allocation of capital, as managements often buy back stock near highs. Given Gilead’s extraordinarily low P/E, the buybacks look to be a good use of capital, Smith says. Gilead also sports a strong balance sheet, with $2 billion in net long-term debt.
Next Monday, Gilead will report second- quarter results. It won’t take much good news to act like a balm—sorry, we couldn’t resist—for Gilead.