Gilead Sciences Has A Realistic Path To $100

| About: Gilead Sciences, (GILD)


Gilead does an excellent job of maintaining ownership over its active drug ingredients, and this creates cash cows that add significant contributions to cash flow per share figures.

The company is ruthless at repurchasing its own stock (it even repurchased its stock throughout the financial crisis) and is set to retire 5-6% of its outstanding shares.

The only concern with Gilead is that it may not be able to maintain its 44% profit margins indefinitely, as charging $1,000 per pill for Sovaldi may prove unrealistic.

Gilead Sciences (NASDAQ:GILD) is an appealing holding for long-term investors for three reasons: it possesses high earnings quality right now, is currently buying back large amounts of stock, and offers a track for long-term growth.

What I like about the Stribild pills (Gilead's signature oral medication for fighting HIV) is the monopolistic arrangement that Gilead has over the drug. By that, I mean the company derives direct ownership from its four major ingredients: elvitegravir 150 mg, cobicistat 150 mg, emtricitabine 200 mg, and tenofovir disoproxil fumarate 300 mg. With many companies that aim to treat viral illnesses, you often find these situations where all of these different companies end up with their hands in the cookie jar, vying for an ownership interest in a particular drug. That is not the case here, as Gilead shareholders are the full beneficiaries of Stribild's success.

What I also like is that Gilead is ruthless when it comes to retiring shares of its own stock, which is an important character trait to possess for a company that throws off copious amounts of cash. Most impressively, Gilead was not one of those companies that only buys back its stock during the good times; it maintained its repurchase program through the financial crisis as well.

Back in 2007, Gilead was divided into 1.865 billion shares. By 2010, the share count had declined to 1.604 billion. Each share of Gilead represented 14% more in profits after the financial crisis compared to the year that preceded it. Gilead's current buyback program is set to continue this tradition, as Bloomberg reported:

Gilead Sciences, the maker of a hepatitis C treatment projected to be the best-selling drug of all time, said it would double the size of an existing $5 billion share buyback program. With the new $5 billion pool, the biotechnology drug company has $7.9 billion to repurchase its shares…

Even at the company's current $135 billion valuation, the $7.9 billion in buybacks is still slated to take 5.85% of its shares off the grid. Think of it like this: Gilead is expected to make $2.55 in cash flow per share, without taking into account the effects of share buybacks. When the share count is reduced by 5.85%, then each share will come to represent $2.70 in cash flow per share. Assuming constant valuation, the execution of the buyback program will add $5.08 to Gilead's share price.

My only concern with Gilead, really, is whether margins will come down for Sovaldi which costs $84,000. It may be difficult for Gilead's 44% operating margins to be sustainable when America's Health Insurance Plans are specifically targeting Gilead's Hepatitis C treatment drug, accusing it of "astronomical" pricing. Tracy Staton at Fierce Pharma summarized the concerns cogently:

Individual payers aren't alone in balking at the $84,000 price for Gilead Sciences' new hepatitis C treatment Sovaldi. Now, the leading insurance trade group has joined the soloists, backing their complaints with its own.

America's Health Insurance Plans (AHIP) targeted Sovaldi in a blog post, giving the Gilead drug kudos for effectiveness--and a big slap for cost.

"Sovaldi has shown tremendous results, and it's the kind of medical innovation we need to sustain," the AHIP blog post states. "Unfortunately, the drug's maker … has priced it at an astronomical level that is not sustainable for consumers, innovation or society."

Gilead has defended its pricing, saying that the drug might be expensive, but it cures patients and prevents costly hepatitis C complications like liver transplants. But the drug brought in more than $2 billion in first-quarter sales--after an approval in December--and could surpass $10 billion this year, some analysts say. That kind of cash flow touched off a new round of criticism.

It's fair to wonder, or at least pay due diligence as part of your stock monitoring process, whether Gilead will can maintain operating margins that are double the drug industry averages (if you blend Johnson & Johnson, Merck, and AbbVie, you will see that their operating margins are in the 21-23% range). My guess is that if Gilead must lower the price of its $1,000 pill Sovaldi, it will be able to rely on volume growth among HCV sufferers outside the United States to increase sales so that the cash flow can still remain strong even if the 44% operating margins taper a bit.

Despite these concerns, it doesn't seem like it is going to take much to get Gilead to an all-time high of $100 per share. When it completes its buyback program, it only takes an assumption of 0% profit growth to get the price to $92 based on the reduced share count alone. From there, all it has to do is increase cash flow per share by $0.25, and assuming its constant 34x cash flow capitalization rate, you will see $8 in price increase, which should take Gilead above the $100 mark. Given the success of Sovaldi in giving patients effective treatment, coupled with the cash cow that is Stribild, the path to $100 seems quite doable for Gilead within the next year or two (assuming constant valuation).

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.