Research May 26, 2017: GILEAD SCIENCES INC. (GILD)
Established Pharmaceutical companies are known for tremendous profit margins and precipitous stock price drops when key drugs lose their monopoly or patent protection. When this happens the essential question is "What is in the pipeline to replace it?"
At first glance at the share price performance of GILD this past year one might think their most important drugs were coming off of patent protection or facing imminent competition. This is not exactly the case. What has happened is an interesting story. One that, arguably, presents a tremendous buying opportunity.
This is a company that had a net profit of $ 18 billion on revenue of $ 32 billion. At a present share price of $ 65 it carries a ridiculously low P/E of 6.5 while the industry average is above 25. Closely scrutinized companies like this donít drop from $ 120 a share 20 months ago to where it is now for no reason so what are the analysts thinking?
The main reason the stock is down are concerns about the declining sales of the blockbuster HVC drugs Ledipasvir and Sofosbavir. Together they account for about 55 percent of total revenue. Ledipasvir alone is a $ 14 Billion drug. These two drugs donít just treat Hepatitis C , they cure it. Since it is a very expensive drug (up to $90,000 for a 12 week subscription) there was always going to price pressure, not only from competitors but from health insurance providers. There is also the issue of the drugs being a cure for a disease not a lifelong treatment like present HIV drugs. Once infected patients with the best health care coverage have been treated, discounting is required, to meet the demands of public and private insurers. This is particularly true in Europe where public insurance is the norm.
Another issue that has had a negative impact is a patent infringement case with Merck Pharmaceuticals. This is an ongoing issue that may cost Gilead a bit of money but it is only a small Infringement case and will not jeopardize the HVC franchise. We believe that the market has been overly harsh on the stock price and that GILD will provide tremendous returns in both the short and long term.
Gilead is a cash generating machine. This allows for a huge R and D budget, dividend payments, share buybacks and, most importantly, acquisitions. Gilead will spend over $ 4 Billion on R and D this year. This is not only important for the "Drug Pipeline ". It creates long term value. Share buybacks totaled over $ 12 Billion in 2016 or over ten percent of the present market capitalization of the company. This is a huge stock price stabilizing program. The dividend yield is about 3.2 percent.
As of May Gilead had over $34 Billion in cash. This is important as the company has a phenomenal track record of adding value through acquisitions. The takeover of Phamasset for $ 11 Billion in 2011 led to the HVC franchise and has added about $ 50 Billion in value to the company. Gilead is also potential takeover target itself. Merck and Pfizer are frequently mentioned in this discussion.
As stated, the expected continuous decline in the HVC drug revenue is the main reason for the stock being unbelievably cheap on a valuation basis. The key question is by what amount their sales will continue to fall and what is in the pipeline that can reasonably be expected to replace it?
We expect sales of the two HVC drugs to continue to decline by between $ 1.5 and $ 2 billion per year for the next five years. This is a particularly pessimistic view but one that realistically is reflected in the current stock price. While the prospect for HIV drugs replacing these declines is not realistic there is plenty of long term potential to argue the stock is undervalued.
Thomas J Atkins, Director of Research, International Trading