Background: I have written twice about Gilead Sciences (NASDAQ:GILD). A few weeks ago I wrote A Physician-Businessman's Views Of Gilead, With Emphasis On Sovaldi, and after the stock price and other biotechs dropped, I followed up with Reevaluating Gilead Sciences After The Sell-Off. In the latter article, I indicated that since the news flow was actually positive but the stock was lower, I thought the stock was a better buy than ever.
Now that an amazing Q1 went into the books Tuesday afternoon, the stock price is back to its prior range, and the stock looks better than ever to me. It may never ever be so cheap again.
Introduction: Gilead Sciences is a phenomenon. As a relatively small player, it made a bold move in early 2012, purchasing Pharmasset for about $11 B to acquire rights to its investigational drug, now approved by the FDA and in Europe to treat hepatitis C, as the product called Sovaldi. Sales of Sovaldi in Q1 were $2.3 B, roughly 90% in the U.S., and European sales began in January and not all of Europe has set reimbursement levels for the product. Japanese sales are expected to begin in 2015. Diluted earnings per share were $1.43, far above expectations of $0.89. The company reiterated guidance for Q2 except for Sovaldi. This lack of Sovaldi guidance perhaps helps explain why the blockbuster "beat" on sales and earnings was accompanied by a modest 3-5% pop in the stock price after hours.
A bit more introduction about Gilead. It is the world's leading purveyor of drug products for AIDS. It has led the movement to producing single pill treatment for AIDS. This is an enormous advantage in convenience, compliance and side effects. One of the components of its lead combination products is tenofovir (Viread is the brand name for the stand-alone tenofovir product). Gilead is well along in development of TAF, an improved version of tenofovir. If this gains approval, it will come out with new versions of all these products, point to safety advantages (so the company is saying) as well as smaller pill size, and likely increase sales and extend its patent protection. Thus it can revitalize its AIDS franchise, which is mammoth and will remain a core focus of the company no matter how successful its hepatitis franchise is. (Note that interestingly, Viread also treats a different form of hepatitis, the well-known hepatitis B.)
Gilead also has two blockbusters that have both been designated as breakthrough products by the FDA that are pending FDA marketing approval in Q3. One is the combination product containing both the active ingredient in Sovaldi (sofusbuvir) and a different antiviral agent that works by a different mechanism against hepatitis C (ledipasvir). This combination could be approved in August. What not all investors realize is how lucrative this combination could be. It will cannibalize a good chunk of Sovaldi sales. This is all to the good for Gilead. What Johnson & Johnson reported last week regarding its anti-hep C drug Olysio was strong sales in combination with Sovaldi (two separate pills). Gilead was asked about that today in the conference call's Q&A. The company's response was that it would be responsible, as most of the value of its upcoming combo came from Sovaldi. My translation is that it will underprice Olysio enough to make its combo a success, but the price will of course be higher than Sovaldi alone. Thus, profits per treatment will rise as Gilead will be selling two novel compounds rather than one.
(Beyond ledipasvir, Gilead has an improved drug in the same class moving toward FDA approval that will replace it, assuming things go well in development.)
Getting back to the pending blockbusters (I hope), Gilead also has an anti-cancer drug, idelalisib. This is also pending FDA and European approval. It was also given breakthrough designation by the FDA for treatment of chronic lymphocytic leukemia (second-line). It is also pending approval for treatment of a form of lymphoma. Assuming approval for both indications, this will be a major product.
In addition to the above, Gilead markets two innovative cardiovascular products; sales were up 9% for them and are close to annualizing collectively at $1 B.
Finally, Gilead was asked on the conference call about its uses for what is now copious free cash flow (NYSE:FCF). The response is that it is not feasible to ramp up R&D quickly in its business. Thus the company is going to be a massive FCF generator, it appears now. Everything from share buybacks, a dividend, increased R&D and product/company acquisitions will be considered at Gilead's headquarters. We might see all of them in the next couple of years.
Discussion - Q1: Product sales doubled to $4.9 B from $2.4 B. Net profits tripled to $1.33 per share (all data are per share where relevant) from $0.43. Note this is $2.23 B in net profit on $4.9 B in sales, which shows why brand specialty pharmaceuticals is a great business for the few companies that can get to Gilead's level.
More to the point, Sovaldi had a full quarter of marketing in the U.S. but not in Europe, where approval is EU-wide but pricing is nation-by-nation. Thus, compared to the first quarter of 2013, U.S. product sales for the first quarter of 2014 increased to $3.63 billion from $1.40 billion and Europe product sales increased to $1.02 billion from $818.3 million.
This shows the power of Sovaldi and its upcoming combo products. U.S. sales were up more than 150% yoy. Europe may not increase that much, but its yoy growth will accelerate. Japan comes next year, where hep C is a bit of an epidemic and is such a major problem that Gilead feels it is worthwhile to build a sales force rather than license the products to a local, established marketer.
The rest of the quarter met guidance, and the company left its Q2 guidance ex-Sovaldi unchanged from its February comments.
The stock's lack of an explosive response was commented upon by MarketWatch, which said:
Gilead Sciences Inc. soundly beat earnings forecasts on Tuesday thanks to its pricey hepatitis C drug, but the biotech giant wasn't getting the after-hours love one might expect from such strong results...
Analysts say, however, that the Street may be more concerned about the long-term prospects for Sovaldi, the company's new hit hepatitis C treatment. The company has been taking heat from health-care providers and regulators for the pricing on its $1,000-a-day drug.
"Under normal circumstances, the stock should trade up. But, of course, investors are suddenly focused on the long-term prospects for Gilead," ISI Group analyst Mark Schoenebaum said in a note to clients. "Will short-term strength increase the Street's longer term confidence?"
My quick answer to Mr. Schoenebaum's question is that it does not matter.
As I e-mailed to a friend before earnings were released, investing is a marathon, not a sprint. Investors are entitled to worry that this quarter's results will not prove representative of the future. This is a proper attitude, one I much prefer committing money in then the cheerleading periods of, say, 1999. My view is that this quarter's sales are unrepresentative because they will increase a lot before they peak. I missed the audio on the first minutes of the conference call, but I think I heard Gilead talk about 17,000 patients treated this quarter. That's a drop in the bucket to the estimated 1.7 MM hep C known patients in the U.S. and the 2+ MM people infected with the virus who do not know it. (Plans are for mass screening now that Sovaldi is out.) Given that Europe is just getting going and Japan is a 2015 event, and that there is a "rest of world" out there, Sovaldi alone and with its upcoming combinations has huge growth ahead, or so it appears now. As first to market and with so many advantages, competitive products have high hurdles to make real inroads into Sovaldi's franchise. Further, it is so easy to prescribe and to take as a patient that we are going to see primary care doctors prescribe Sovaldi once the regimen becomes the combination pill only. This will drive scripts, and internists and family physicians are very loyal to major products such as a Sovaldi/ledipasvir combo; they do not want to learn how to use a competitive me-too product.
Writing both as a physician and former pharmaceutical executive, Sovaldi is an immense breakthrough, and because of it, the cost per cure of hepatitis C will come down. Its pricing is appropriate for the U.S. cost schedule, and I have heard that Germany has approved the same reimbursement level as here. Sovaldi is a once a day pill with few side effects that allows a reliable cure of a fatal infectious disease, which could be transmitted through unprotected sex to someone you personally know and may love.
I am therefore confident that all the publicity about price is nonsense from a GILD stock/Gilead business standpoint. It may have been put out into the public domain with such emphasis by short sellers, or conversely by bulls who saw the amazing Rx strength and wanted one last chance to buy the stock below $70 (barring market crash). Now I wonder if the game is, per MarketWatch, to get to buy the stock in the $70's before it heads to all-time highs and therefore to express concerns about the future.
What's the upside for GILD?: This stock now reminds me of Apple (NASDAQ:AAPL) in January 2010. It is high; I think it will go higher. Of course, no comparisons are exact; the iPad was not as massive an accelerant to Apple's growth as the Sovaldi complex is to Gilead's, and by early 2010, AAPL had to claw its way up in price to reach pre-crash levels; meanwhile we are five years into an almost uninterrupted bull market. But for what it's worth, AAPL was a bit disrespected despite its wonderful achievements including the pending iPad, which had mega-hit written all over it, but its growth was discounted for unknown and bogus reasons. I feel the same way about Gilead now. It has become one of the great growth stories of our era by developing and marketing drug product after product that have changed for the better the lives of vast numbers of people in the U.S. and the world. It has not bothered with "me too" drug products or generics; it has had few disappointments; it has had a relatively clean record with FDA; etc.
Before blowout earnings, it was already the cheapest large cap growth stock relative to the market I have seen in years except AAPL as described above. Gilead has grown sales per share about 40% per year over the past ten years. Pretty good! Now it is doubling sales yoy- an acceleration. Better!
Gilead is a huge FCF generator. For all its past greatness, GILD was trading at a pathetic 12X predicted 2015 earnings before earnings were released Tuesday. GILD was trading at an even more pathetic 10X P/E on mean 2016 earnings. Remember, in pharmaceuticals, 2015 is like tomorrow and 2016 is just around the corner. These are ridiculously low valuations that implicitly assume that Gilead will cease successful product development after Sovaldi and the current pipeline do their things. But there is no reason to expect other than continued success, though of course a company as large as Gilead cannot accelerate from 40% to 100+% and keep accelerating.
Again, given its FCF characteristics, a 12X P/E is an 8% earnings yield that the company actually receives in cash that year. A 20X P/E is still a 5% earnings yield, and for a growth stock, that's attractive.
In the real world, this is what I expect: Investors will realize that there is no equivalent to Gilead/GILD.
Back in the days of Wall Street Week, someone would say that you should buy "an IBM (NYSE:IBM)" or "a GE (NYSE:GE)." I would get irritated and say there are no equivalents. Either buy IBM or GE or not. There was nothing "like" IBM or "like" GE enough to use that term. The same is true for Gilead. There is no other company with its cash cows, pending upgrades to its cash cows, pipeline-- and Sovaldi, at the current below-market P/E. GILD is a sui generis stock. I think it is on the equivalent of a fire sale - but it is hardly damaged goods. It is a glamourous company because of its achievements, and soon enough its stock can reflect glamour stock valuations.
As a comparison, within biotech/biopharma, Celgene (NASDAQ:CELG) is a fine company but it is trading at more than 25X Value Line's expected 2015 GAAP earnings. This is high in comparison to GILD's metrics. Regeneron (NASDAQ:REGN) is a fine company too, but again it is trading at about 45X projected 2015 earnings found on Yahoo! Finance, and estimates for this year and next have come down sharply. Meanwhile estimates are rising sharply for GILD. The difference in P/E's between GILD and these and many other biotechs makes little sense that I can see.
I am thinking of numbers like $10 EPS and a return to its historical 22X P/E to provide a triple in 1-2 years for GILD.
In any case, I think the downside on GILD shares is limited, again barring a general market crash, while the upside is very large. I think that GILD could sustain an uptrend for a long time to come, as both earnings and P/E could trend higher. The Street is cautious about whether Sovaldi, as a curative agent, will burn through the pool of patients needing treatment rapidly. I do think it is incorrect to think that GILD stock is so cheap that it will earn its entire market cap with Sovaldi and hep C sales, but the essence of growth stock investing involves faith in the company to use its current and expected future profits from current products to fuel development and sale of future profitable products. Thus I remain a bit surprised by the initial restrained reaction to Q1's results, but I think it's reflective of a more sober approach to stocks post-Great Recession and thus can be explained as quite reasonable.
Summary: I am approaching 35 years of investing in stocks. I have had some big winners. Some were pharmaceutical stocks, and one was AAPL post-Great Recession. GILD has the look of another big winner. Investors are fearful of competition to Sovaldi and combinations involving Sovaldi. But as Warren Buffett has said, one of the keys to winning in the investing game is to be bold when others are fearful.
I do not believe that investors should look the GILD gift horse in the mouth. GILD strikes me as one of the most grossly undervalued large cap growth stocks ever relative to the market, roughly on a par with AAPL of 2010-11. Based on what I know now, I am hoping to be able to acquire a good deal more GILD stock around current after-hour levels in the near future. Are there risks? Of course. Wall Street is not a charitable institution, and the efficient market hypothesis is not total garbage. Wall Street does however continue to exist because people tend to make money there. My sense is that GILD is the real deal from an investment standpoint and that one of these days, investors will bid it up to a higher P/E, and especially a much higher relative P/E - but with the "E" being a substantially larger denominator than it is now.
Having written all this, I must emphasize that nothing herein constitutes investment advice to anyone, and that I await future results from Gilead with great interest but no inside or other special knowledge. What twists and turns the Gilead story will take keeps me in suspense. I hope for a happy ending!
Disclosure: I am/we are 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.