A Physician-Businessman's Views Of Gilead, With Emphasis On Sovaldi

| About: Gilead Sciences, (GILD)


Gilead Sciences is proving to be an immensely important corporation;it markets most of the leading AIDS treatments.

Gilead has now begun its worldwide rollout of Sovaldi, a paradigm changer in hepatitis treatment.

Yet the stock has gone nowhere since FDA approval of Sovaldi along with other good corporate newsflow.

This article engages in qualitative and quantitative analysis supporting the view that Gilead shares are severely underpriced.

Background: Because a game-changer like Gilead Sciences (NASDAQ:GILD) Sovaldi comes along infrequently, some historical examples are in order. I have seen several breakthrough drug products in my roles as physician as well as via multi-year involvement in the pharmaceutical industry in various capacities.

One such game-changer came in the late 1970's with the FDA approval of the specialized antihistamine Tagamet. Promptly the common surgery for bleeding ulcers became obsolete as Tagamet was used widely from the start. The company that marketed Tagamet was SmithKline & French. A few years later, the smallish British firm Glaxo came up with a similarly efficacious "H2" blocker called Zantac. Because Zantac's dosing was more convenient than Tagamet's it became #1 in market share. But both companies prospered, and interestingly they combined to form the globe-girdling giant we know today as GlaxoSmithKline (NYSE:GSK). No one thinks of H2 blockers nowadays when thinking of GSK, but that's the way it was.

And that's the way I think it may turn out for Gilead down the road. Sovaldi is the focus now, but a full-fledged biopharmaceutical company is coming to the forefront of its peers.

Introduction: Gilead is (was) a site in Jordan that was the source of a naturally growing plant that yielded a healing balm. Gilead Sciences has proven to be one of the pharmaceutical companies that has made a major difference to the health and well-being of people throughout the world. It pioneered the development of an efficacious treatment for influenza (Tamiflu) and developed and markets many (OTCQB:MOST) of the leading AIDS treatments. It has grown by internal product development, product acquisition, and corporate acquisition. The stock has appreciated about 120X since going public in 1992, for a compound annual appreciation rate of 24%.

However, slowing growth in its AIDS franchise, disappointing financial results from its diversification into marketing a cardiovascular agent (Ranexa, which came via a costly corporate acquisition), and the Great Recession helped quell the stock price upturn. Then, some renewed growth, the January 2012 acquisition of Sovaldi via another corporate acquisition (of Pharmasset), and favorable news about Sovaldi helped the stock quadruple, as seen in these two charts of GILD:

Splits: Feb 22, 2001 [2:1], Mar 8, 2002 [2:1], Sep 7, 2004 [2:1], Jun 25, 2007 [2:1], Jan 28, 2013 [2:1]

Splits: Feb 22, 2001 [2:1], Mar 8, 2002 [2:1], Sep 7, 2004 [2:1], Jun 25, 2007 [2:1], Jan 28, 2013 [2:1]

It's interesting that the pattern of the 22 year chart on top is very similar to that of the 5-year chart below it; a fractal of a sort.

The argument is now being made that the stock is "too high". Let's examine that proposition.

Financial analysis: Product sales increased 15% from 2012 to 2013, from $9.40 B to $10.8B. The rate of increase accelerated from Q4 to Q4, increasing 21% yoy, but that was due to $136 MM of initial sales of Sovaldi. Basically, the company's business has been decelerating, and the stock has soared since 2012 in anticipation of Sovaldi as well as other hoped-for pipeline successes (to be discussed after Sovaldi). The company has guided for non-Sovaldi product sales this year of $11.4 B, representing a modest 7% yoy increase. The company's guidance is also for a strong R&D spend of $2.25 B. Investors should be aware that this R&D expenditure lowers earnings but may be a better use of cash than banking the money or returning it to shareholders.

As is typical with biopharmaceutical companies, GILD trades at a high multiple of book value and carries little cash on the books. The company has never paid a cash dividend, but it shrank shares outstanding from 1.865 B in 2006 to 1.506 B in 2011. Since then, the share buyback program was suspended largely because of the $11 B cost of acquiring Pharmasset (which developed Sovaldi).

In any case, it's all about Sovaldi, so let's discuss it.

Sovaldi - why it's for real; how lucrative will it be?: The human liver is prone to infections by five types of virus. Three of these types are chronic, and are called hepatitis ("hep") B, C and D. Hep B has been known for many years, and in recent years, increasing attention has been directed to hep C. These share the same routes of transmission, namely sex, shared needles, etc. Both can cause liver dysfunction, loss of functioning liver cells, liver failure, and cancer of the liver. It is estimated based on CDC data that 1.7 MM Americans are known to be infected with the hepatitis C virus, but that perhaps 2-2.5 MM more are also infected but have not been diagnosed. (It is anticipated that all Baby Boomers are going to be offered hep C testing now that Sovaldi provides an effective backbone of treatment and cure.)

The hep C virus has six subtypes, and is approved for treatment in subtypes 1-4 in the U.S. (This covers the vast majority of cases.) Subtype 1 is the most common.

Sovaldi is a breakthrough in several ways. One way is that it is effective against all the common genetic subtypes and perhaps against all six subtypes. It has brought 95% cure rates when used in combination with the appropriate other medicines, an astounding result. It is also an oral, once-daily medicine with few side effects. All in all, it can be considered a game-changer for the treatment of hep C disease.

Furthermore, it is anticipated that a combination of Sovaldi plus another Gilead drug will likely be approved by the FDA this year for treatment of hep C, subtype 1. This would represent the first all-oral (and, once-daily) treatment ever achieved for this disease. Efficacy has been 95%+, and treatment is only for 8-12 weeks in most cases.

Experts have been quick to recognize Sovaldi as something special. For example, the American Association for the Study of Liver Diseases in conjunction with the Infectious Disease Society of America have incorporated sofosbuvir (the chemical name for Sovaldi) in their first-line treatment guidelines for initial treatment of hep C virus disease.

Gilead is the worldwide patent-holder for sofosbuvir, though as was discussed recently on Seeking Alpha, there are patent challenges. It has set up a marketing subsidiary in Japan, where liver cancer is the most common cancer and most cases are believed to be due to hep C. Sovaldi has been approved in Europe and Canada, and filings in Japan are expected soon. (On Wednesday, the company announced success in a phase III Japanese trial of Sovaldi.)

Sovaldi's retail price in the U.S. approximates $1000/pill. A 12-week course of treatment may have a list price of $80,000. This is actually in line with other prices for drugs for hepatitis with lower efficacy. Unsurprisingly, Congress could not resist grandstanding the issue, and that helped spur a sell-off in GILD shares as well as in the overheated biotech sector recently. Nonetheless, Gilead's team is highly experienced in this topic, and knows how to sell large amounts of product at prices that make shareholders happy.

The company refuses to comment on how Sovaldi sales are doing this year. Analysts who track estimates of prescriptions are optimistic, however. From a Barron's March 7 blog:

Citigroup's Yaron Werber explains:

Sovaldi is tracking at $943M for the first twelve weeks of launch and could post $8.76B in sales for 2014 and $1.59B for Q1:14 vs. Citi $516M and Consensus $903M, if Sovaldi scrips continue at same level as the recent week without any growth. We anticipate that Sovaldi could materially exceed our and consensus ests and believe that posting >$5B in total sales in FY14 is possible. In the twelfth week of launch, Sovaldi's weekly TRx were 6,398. While this is only the twelfth week, it is still much ahead of protease inhibitor Incivek' launch which had 1,928 TRx in the twelfth week of launch.

The same Barron's columnist quotes the same analyst this week:

Based on the strong demand for Sovaldi, we are raising ests in 2014-'16 to $7.5B, $11B, $12B, then flattening sales out from '16-'18, and reducing them to $6.5B by 2023.

These are extraordinary numbers. Are they feasible? I think they are.

Let us assume that in the "rich" countries, there are 10 MM total hep C patients. Also, globally it has been estimated that there are 150 MM people infected with hep C. Gilead may be able to retain all the profits including marketing profits in the rich countries but not elsewhere, so I'm going to assume arbitrarily that it can make its full profit off of 15 MM "rich equivalent" patients. I'm also going to assume after-tax profits per course of Sovaldi of $20,000, based on sales to Gilead of $40,000 per patient. Can Sovaldi be used in 20% of that 15 MM number? If so, we are looking at 3 MM X $40,000, or $120 B in total sales, or $60 B in aggregate profits.

The truth is, we simply do not know. Gilead executives say in the February earnings conference call and in a March conference that both specialists and internists are excited about Sovaldi, and the company anticipates developing new combinations of drugs based on Sovaldi as the years go by. They are going to engage in direct-to-consumer marketing, as well, likely encouraging screening as well as treatment.

Having seen transformative medicines appear now and then since my medical student days in the late 1970's, I can relate unequivocally that breakthrough meds with a clean administration and side effect profile tend to exceed analysts' expectations. However, Sovaldi is peculiar in that it is a cure most of the time, so there is no "razor blade" effect; many potential patients require a blood test to become aware they have the disease that Sovaldi treats; and the price per use is unaffordable to all but a very small segment of the population except for insurance/charity. I can also say that it is rare for breakthrough meds to avoid effective competition.

Seen on a Yahoo! Finance message board was this (alleged) report from UBS, suggesting that Sovaldi is doing very well so far:

UBS today ...

"Sovaldi scripts for the week ending March 28 were released this morning with total scripts of 7,434, up 4% from last week. New Rx were 3,878, up 4% w/w. This is the last full-week data in 1Q, and there will be one more day's scripts left this month.

A total of 58,865 scripts and 37,636 new scripts have been recorded in 1Q through March 28. These numbers show that 1Q revenues would beat current 1Q Sovaldi consensus (Bloomberg) of $705m.

The math implies that conservatively, we are tracking to $2.5b already:
- Assume 95% complete therapy (97.5% refill in months 2 and 3 each)
- Assume 12% gross-to-net pricing (more conservative than Gilead comments imply)
- Apply the 0.88 correction factor suggested by 4Q scripts vs. reported demand
- Assume 10% of NRx are actually refills "

Given all the uncertainties, if Gilead had little else going on in the R&D department, I would say that potential competition, such as appears to loom next year from AbbVie, to Sovaldi would make the stock little more than average. However, there are two specific low-risk positives coming in the next year to few years that make me believe that GILD is a buy.

TAF: The first is that the company says that it has improved upon Viread, which chemically is tenofovir disoproxil fumarate. Viread is indicated for chronic hepatitis B, and is an important mainstay in more than one of Gilead's combination products. The company has developed a different version of tenofovir, which it abbreviates as TAF, that it says has a superior safety profile as well as being more potent, allowing for smaller tablet sizes. This is likely to lead to several new combination medicines, with Gilead's goal being to bring "creative destruction" to its own leading products by making sure that their replacement is from Gilead itself. The improved safety profile apparently includes renal toxicity, and this may be clinically meaningful; we will have to stay tuned, but TAF may benefit patients and GILD investors both in a meaningful way.

Oncology: Gilead also is well on the way to making an important contribution to oncology treatment. The reasonably common blood malignancy called chronic lymphocytic leukemia (CLL) is often difficult to treat successfully. Gilead has shown persuasive data to the FDA that its investigational product idelalisib deserves accelerated review for use in treating CLL; i.e. the FDA is considering it as being a breakthrough product for this indication. The PDUFA date is in August. Idelalisib has also been filed for a different hematologic malignancy, indolent non-Hodgkin's lymphoma. Its PDUFA date for that indication is in September. This drug may lead to significant sales for Gilead.

Other: Gilead also has a cardiopulmonary division with two main products. These are Letairis, the leading endothelin receptor antagonist for pulmonary arterial hypertension, and Ranexa, a novel anti-anginal for which Gilead is investigating additional indications. Gilead also garners 21-22% royalties on sales of the influenza preventative and treatment Tamiflu; its patent protection expires in 2016.

Management: The two top executives at Gilead have been with the company since 1990. Others have had long tenures there, as well. I view this consideration as a material positive.

Technical considerations: The recent correction saw GILD bounce at its 200 day exponential moving average. So far the rebound is unconvincing. The stock is in a downtrend short term; as of now, this is minor given its intermediate and long term uptrends.

Projections: The Street is now looking for massive growth in revenues due primarily to Sovaldi, both alone and in a combination tablet with another Gilead anti-hep C drug (ledipasvir). Thus Yahoo! Finance reports the following sales and EPS projections:

Revenue Est Current Qtr.
Mar 14
Next Qtr.
Jun 14
Current Year
Dec 14
Next Year
Dec 15
Avg. Estimate 3.68B 4.04B 16.46B 21.26B
No. of Analysts 21 21 26 27
EPS Trends Current Qtr.
Mar 14
Next Qtr.
Jun 14
Current Year
Dec 14
Next Year
Dec 15
Current Estimate 0.82 0.95 3.86 5.82
7 Days Ago 0.81 0.93 3.84 5.73
30 Days Ago 0.80 0.91 3.78 5.65
60 Days Ago 0.69 0.81 3.39 5.42
90 Days Ago 0.64 0.76 3.27 5.18

There is risk as well as opportunity here. The uptrend in EPS estimates since Sovaldi was approved in December (U.S.) and in the EU (January) is encouraging to the bulls. However, it is now estimated that sales are going to grow by about $10 B from 2013 to 2015. If so, and if $5.82 is correct for 2015 EPS, what is the proper P/E the market should give those earnings? Beyond that, the Street is modeling GILD as trading at 10X 2016 EPS of $7.26/share, with a wide range as one should expect given all the uncertainties.

Right now, if we assume the above projections are on target, GILD is trading at 18X next 12 month's EPS and 9-10X 2016 EPS incorporating part of 2017.

There is much talk of bubbles, and there have been sell-offs in momentum stocks. Certainly GILD has risen sharply since the Pharmasset acquisition, but given the company's track record, growth prospects within the relatively non-cyclical pharmaceutical field, there's nothing in its current valuation that smacks at all of speculative froth. After all, an 18X P/E translates to a 5.6% earnings yield (the reciprocal of the P/E). In today's world, that's a high interest rate, and if you believe as I do that there is more growth to come, you may find it fundamentally attractive to own the asset producing those earnings.

Risks: GILD has minimal net liquid assets, so the valuation is all about the future. This is a future that has not occurred yet, so there are immense downside risks if matters go poorly for the company, or simply if the stock market has a major revaluation lower. Sovaldi could fail to meet expectations, and AbbVie's competition and other competition could be stiffer than expected. Idelalisib may never get approved; the same could be true for TAF. Thus the stock could easily drop to a much lower trading price. Also, there is no dividend underpinning the share price.

Gilead (the company) is "safe" in that it markets several critically important pharmaceuticals which rich societies have committed to reimburse generously, but there is nothing safe about any particular trading level for its stock.

As was mentioned earlier, there are patent challenges to Sovaldi. How material these may be are impossible for me to assess.

Of course, many other specific risks can be named, but there's no need to do this. GILD can go down and stay down - permanently. One never knows.

Conclusion: Now that Gilead has had what appears to be a successful launch of its important new therapy for hepatitis C, at least in the U.S., and may be within a year of launching both a combination product for hepatitis C of which Sovaldi's active ingredient is one of the two drugs as well as launching a potential breakthrough second-line treatment for chronic lymphocytic leukemia, it may be one the verge of an important growth phase. Growth may be sustained by the replacement of Viread with TAF, perhaps as the gigantic growth surge of Sovaldi and its combination products tapers off.

The current sell-off in momentum stocks, including many biotechs, has involved GILD. I am looking at this as a buying opportunity in these shares for patient investors, with the important caveat that the overall market is richly-valued, so true bargains simply do not exist anywhere that I am aware of. In addition, GILD shares have earnings risk and market (P/E) risk, and they pay no dividend. They are not for the faint of heart, but I do not believe that investors should confuse Gilead with a one-product or (heavens forbid) development-stage biotech stock. This is a large company with lots of cash flow and a clear blockbuster in Sovaldi and its follow-on products. Thus I for one would be cautious about a strategy of purchasing or owning GILD and selling on weakness; I am optimistic that the company's business has a reasonable amount of stability.

GILD may thus in my view be considered as a core holding for investors interested in growth and who want individual stock exposure to the biopharmaceutical field.

Disclosure: I am long GILD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Not investment advice. I am not an investment adviser.