Reevaluating Gilead Sciences After The Sell-Off

Apr.14.14 | About: Gilead Sciences, (GILD)

Summary

Much news has occurred since I wrote about Gilead very recently.

The only material changes are for the better for new money investment.

The stock may now even appeal to value investors.

Background: On April 7, Seeking Alpha published an article I wrote on Gilead Sciences (NASDAQ:GILD). Since then, a substantial amount of news has hit the wires about this company. The focus has been on its recently-introduced product called Sovaldi, which has been deemed to be a breakthrough treatment for the liver disease known as hepatitis C. Because of the intense investment interest in GILD and Sovaldi, it appears appropriate to provide readers with a summary of the news and a re-evaluation of the values inherent in this security.

Introduction: Gilead has pioneered a number of important remedies. It receives royalties on the innovative oral treatment for influenza, Tamiflu. It is the leading developer and marketer of drug products for HIV sufferers. Its Viread (tenofovir) pill for AIDS also treats hepatitis B. The company is well along in developing an improved version of tenofovir, which it is calling TAF. Gilead intends to file TAF as a standalong replacement for Viread as well as use it in combination products which now contain tenofovir. The company additionally has filed for FDA approval and received breakthrough designation for idelalisib, a biotech drug for chronic lymphocytic leukemia (CLL). This drug also underlies a different but related NDA filing for use in indolent non-Hodgkin's lymphoma.

The pipeline involves important advances beyond Sovaldi, which was approved for marketing in the U.S. in December and in Europe in January. FDA has given breakthrough designation to a combination product containing the active ingredient in Sovaldi (sofosbuvir) and ledipasvir, which works by a different and complementary method to sofosbuvir. A follow-on product that may be an improvement over ledipasvir is also in development (GS-5816).

Often overlooked is Gilead's cardiopulmonary division, which is nearing $1 B in annual sales. The most impressive medicine in it is Letairis, the country's leading endothelin receptor antagonist product for treatment of primary pulmonary hypertension.

In any case, right now the stock is rightly moving on news relating to hepatitis C and Sovaldi. Let's see what's been happening, starting with complaints about Sovaldi's cost.

Express Scripts' (NASDAQ:ESRX) comment: As Bloomberg.com reports (via the linked Barron's blog) :

Express Scripts plans to ask its clients, composed of national employers, health insurance plans and government agencies, to join a coalition that would stop using Sovaldi once a rival medicine is approved for the U.S., expected next year, said Steven Miller, chief medical officer of the St. Louis-based company. Express Scripts said in December it may block reimbursement for Foster City, California-based Gilead's pill once other new hepatitis C therapies are on the market…

AbbVie Inc. (ABBV) said it will file for FDA approval of its hepatitis C combination therapy in the second quarter after a study found it cured 99 percent of patients after 12 weeks. Miller said he hopes companies selling hepatitis C drugs in the future will talk to payers before setting a price.

However, the same Barron's blog itself quotes an analyst as rebutting this as follows:

Here's the thing though: this plan by the PBMs requires that the drug companies "play ball."

That is, it requires that [AbbVie (and Bristol-Myers Squibb (BMY), Merck (MRK), etc)] offer truly meaningful price discounts to [Gilead Sciences'] regimen. Thus, the future of Hep C pricing still appears to be largely in the hands of the branded drug industry. And there really isn't much precedent at all for branded companies competing on price in a MAJOR (~double digit) way. Plenty of companies play around with rebates and discounts, but it's rare that the net price difference between major brands is more than a few percentage points...

However, all the rhetoric that I've heard coming from [Gilead, AbbVie, Bristol-Myers Squibb, Merck,] etc is that they do NOT believe the hep C market will behave this way. They view it as a market that has long term potential.

These general comments about the reluctance of brand companies to compete on price are precisely correct. This is for at least two reasons. One is that they are thinking long term. The also-rans do not gain much in a price war, and they all lose longer-term from such behavior. The other is that each product is unique, and the brand companies resist the idea that their products are commodities because they treat the same disease.

Specifically re Sovaldi, a follow-up blog post the next day provided encouraging opinion about its pricing and relative value:

Gilead was pilloried again yesterday for developing a drug (Sovaldi) with the highest efficacy and fewest side effects, but at a high (but not the highest) price for a new HCV therapy. The cost-benefit ratio suggests it is not the most expensive therapy in the HCV space... We view these statements as noise and believe that Sovaldi and next-generation Ledipasvir/Sovaldi represent real pharmaco (economic) value in the HCV space.

While I have not seen the data referred to, I have no reason to doubt the veracity of the above opinion. The Gilead team is very experienced with high-priced, breakthrough medicines and would be expected to present insurers with sophisticated pharmacoeconomic analyses to support its pricing structure.

Financial Times summary: The FT stepped into the fray on April 13 with an article titled Drug groups step up race for hepatitis C treatments. This is some of what it says:

Gilead Sciences is leading the field after the approval in December of its Sovaldi treatment, on course to become the most successful new drug in the industry's history, with analysts forecasting sales of up to $10bn in its debut year.

But others are scrambling for a share of a market expected to reach at least $20bn of sales by the end of the decade...

Before Sovaldi's launch, hepatitis C patients had to be treated for up to a year with multiple drugs - including an inconvenient injected medicine - that produced much lower cure rates and worse side effects.

Drug industry leaders say Sovaldi and rival medicines will save money in the long run by reducing the number of cases in which hepatitis C leads to serious liver disease - including cirrhosis and cancer - requiring more costly treatment.

Given the exalted status of the FT, I think we can assume that the prescription numbers for Sovaldi have indeed been strong; otherwise it would not have pegged Sovaldi to be the most successful drug product launch in history in dollar terms.

Putting all the above together, I think that in the world as we know it, the complaints from Congress, Express Scripts and others about the price of Sovaldi have merely shaken some weak holders out of the stock. Has there been coordination with short-sellers? I would not know, but stranger things have happened.

Competition; focus on Merck: GILD sold off the day after Merck presented, in a liver conference in London, some Phase II data on two investigational drugs used in combination in one prevalent genotype of hepatitis C. There was follow-up data presented the next day in more refractory patients. This brought home to investors the importance of considering competition to Gilead's evolving complex of hepatitis C products, including Merck. This induced Barron's to weigh in again with what I view is interesting comments, which I present in some detail:

Mark and other analysts have already assumed [Gilead Sciences'] mkt share will drop to ~60-75% in G1 share at peak. Key question is who grabs the other ~25-40%? [Merck] seems to be leading contender for this now...

So, investors must be aware, the analysts are not dummies; they know competition is coming. They have modeled it. Are they correct in market size in toto? On that we will have to see; but, stock market sell-offs as competitors strut their stuff often are classic buying opportunities in the pharma biz. The Barron's blog continues, quoting a different analyst (which I quote in full):

We are raising our revenue estimates for Gilead's HCV franchise as we take into account strong prescription data to date and more importantly comments by renowned hepatologist, Dr. Stefan Zeuzem, on emerging competition from AbbVie and Merck. We believe recent sell-off in [Gilead Sciences] provides investors an even more compelling buying opportunity, as our dinner with Dr. Zeuzem highlighted key advantages for Gilead's HCV combo of sofosbuvir + ledipasvir. In particular, Dr. Zeuzem pointed out the need for ribavirin with AbbVie's regimen when used in genotype 1A cirrhotic patients and physicians' general aversion to using this regimen in HIV co-infected patients given use of a ritonavir booster. For Merck, Dr. Zeuzem suggested keeping an eye on rates of Grade 3 ALT elevations.

At the same conference (EASL), Gilead presented its own impressive data. This involved Sovaldi alone, sofosbuvir/ledipasvir in combination, and sofosbuvir/GS-5816 in combination (three different press releases can be seen). As one of the presentations said:

"The patients included in these analyses are historically among the most difficult to cure, and many have had no appropriate treatment options until now," said Norbert Bischofberger, PhD, Executive Vice President of Research and Development and Chief Scientific Officer, Gilead Sciences. "These data demonstrate that Sovaldi-based oral therapy can improve outcomes, has a favorable safety profile and is well tolerated among hepatitis C patients with severe liver disease."

OK. I'm not worried right now by competition per se. What's GILD worth?

Valuing GILD: Since Gilead sells at a very high price:book ratio, and has more long-term debt ($4 B) than net working capital ($1 B), it's reasonably conservative to assume that all its value resides in its future cash flows. These look to me to be very large. As Barron's, again, asks, is GILD now a value stock as well as one of the great growth stocks of our era? It can be answered, that perhaps it is, again with the caveat that an attractive free cash flow yield to a stock does not make an equity a true value play in the classic sense. From the blog:

GILD trades at 10% and 12% free cash flow yield on 2015E and 2016E, respectively. Bears will say that's because of an HCV cliff afterwards, but the point is when it trades at these levels it implies the market is already thinking it's a cliff.

Yet, the FT piece shows that the industry is thinking there is no cliff any time soon.

On a P/E basis, Gilead's Investor Center shows that the mean earnings estimate for 2016 would give the stock, if unchanged, a P/E about 9X based on average expected earnings of $7.39. Yet Value Line reports that GILD's median P/E has been 22X. In fact, Value Line has very conservative EPS estimates of "only" $4 (all data are per share where relevant) for the 3-5 year time frame yet still projects a price target of $100 by then.

Among other independents, S&P Capital IQ pegs GILD's intrinsic value to be around $113 (very high relative to all other stocks it rates). It also gives GILD's "Investability quotient percentile" to be very high at 97%.

Fidelity provides a variety of independent stock rating services for its clients and aggregates their ratings. For what it's worth, GILD gets an average rating of a very high 9.5. Technically, Ford Equity Research asserts that GILD's pattern of a strong 12-month appreciation but negative price action in the past month and past three months suggests upward price action to come and historically represents mere consolidation in an uptrend.

My own view is that GILD is fundamentally attractive, especially given that the combination of rich valuations on both the equity and fixed income (and cash) markets means that many alternative homes for capital look overpriced.

Risks: While one can be heartened by the apparent lack of any serious side effects showing up with Sovaldi, one cannot rule out that something devastating such as a rare case of aplastic anemia could occur and allow competitive products to surpass it. More to the main stream of what could go wrong, the market for hepatitis C antiviral treatments could prove smaller than expected, and/or competition could be tougher than I expect. Growth stocks could go out of favor. Pharmaceutical companies in particular may face greater pressure on selling prices from governmental and societal forces than the smart money now is anticipating.

Beyond hepatitis C, Gilead may face pressures in the growth of its AIDS complex for any of a number of reasons. Its cardiopulmonary division may struggle, and its pipelines beyond Sovaldi and its combination products may prove not to be wonderful.

As I said in my prior article, Gilead as a corporation has a good deal of stability, but the stock quadrupled from the time it acquired Sovaldi until its recent peak, so much has been priced in. Thus, predicting the behavior of its stock may be more difficult than predicting its growth rate-- and that's not easy in and of itself. We could simply see a period of prolonged consolidation of the stock price even if bulls on the stock such as myself are eventually proven correct.

Summary: The biotech complex has had a very rough time of it lately. Yet to compare a company, Gilead Sciences, which has grown sales at a compound annual rate of 40% for the past 10 years, and which has Sovaldi and other products poised to allow it continue its amazing growth, with speculative young money-losing companies, is to compare an apple with a young crabapple. Because of such factors as its high price:sales and price:book valuations, GILD is not a "deep value" stock, but it appears to me to be as good a buy as these equities tend to get other than at or near the bottom of the occasional liquidation events that come at unpredictable times. Investors who can handle downside price action may find GILD's current price under $67 attractive.

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.