Background: Gilead Sciences (NASDAQ:GILD) may remain substantially undervalued relative to the market despite its tremendous stock price appreciation recently and over many years. The following shows GILD versus the S&P 500 and the NASDAQ since this Yahoo! Finance chart begins with Gilead's IPO, with GILD at a split-adjusted $0.63 in January 1992:
GILD has returned 24.6% annually on average since then, by my calculation, dwarfing the main indices. This impressive result has been accelerating, which I take as strongly positive. In the past 12 months, GILD has risen from $53 to $88.86, a 68% increase. This is not a one-year wonder, either. In the past five years, it has risen from $22. That's a 32% compound annual return, and it encompasses a period in which GILD underperformed the indices.
Is GILD still poised for outperformance, or has a bright future already been fully discounted?
Ahead of the July 23 earnings release, this article provides an update about Gilead in a number of areas, based on recent news, data and management comments.
Introduction: Gilead is and has been one of the global leaders in antiviral therapy. Its Vistide was approved by the FDA in 1996 for treatment of an eye infection, cytomegalovirus retinitis, in AIDS patients. Tamiflu, which it discovered, was approved in 1999. Since then it has become the clear global leader in anti-HIV medications.
One of the themes of this article, and a key rationale for investing in Gilead, is its management savvy. This is of longstanding nature. Often what a young company does not spend money on is very important. For example, Wikipedia reviews Gilead's history and mentions:
In 1990, Gilead entered into a collaborative research agreement with Glaxo for the research and development of genetic code blockers, also known as antisense. This collaboration was terminated in 1998, and Gilead's antisense intellectual property portfolio was sold to Isis Pharmaceuticals.
Now, Gilead did a lot right in the 1990s, and this decision to not work on antisense technology looks like a wise or lucky one (compare the chart of ISIS to that of GILD if one doubts that).
Gilead has successfully brought anti-HIV treatment to its current state by taking the lead in developing and promoting the one pill, once daily treatment paradigm. This maximizes patient adherence and by doing so both improves control of the disease and minimizes development of viral resistance. That paradigm is important as we review the competitive position that Gilead is expected to face in the anti-hep C market in 2015 and beyond and as it broadens its focus beyond Sovaldi.
Hepatitis C developments: On Monday this week, Bristol-Myers Squibb (NYSE:BMY) announced marketing approval in Japan for a dual regimen for hepatitis C, genotype 1. The approval has certain limitations that might slow the uptake of this regimen, per the company:
The Daklinza+Sunvepra Dual Regimen
The indications for Daklinza and Sunvepra in Japan are for the improvement of viraemia in either of the following patients with chronic hepatitis C genotype 1, or chronic hepatitis C genotype 1 with compensated cirrhosis: (1) patients who are ineligible or intolerant to interferon-based therapy, and (2) patients who have failed to respond to interferon-based therapy.
Since it will be some time until Gilead's sofosbuvir (the active ingredient in Sovaldi) plus ledipasvir combination product will make it to the Japanese market for hepatitis C infection, genotype 1 - perhaps late 2015 - the BMY dual regimen will treat and cure a number of the estimated 1.2 million Japanese with hepatitis C. Thus it may cut into Gilead's ultimate commercial success there.
In the rest of the world, though, I'm not overly impressed with the BMY current plans for its anti-hep C product positioning. This is how Bristol-Myers describes its product plans for other countries, in the above-linked press release:
At the core of our pipeline is daclatasvir (DCV), an investigational NS5A replication complex inhibitor that has been studied in more than 5,500 patients as part of multiple direct-acting antiviral (DAA) based combination therapies. DCV has shown a low drug-drug interaction profile, supporting its potential use in multiple treatment regimens and in people with co-morbidities.
DCV is currently being studied in the ongoing Phase III UNITY Program, where it is being investigated as part of an all-oral 3DAA Regimen (daclatasvir/asunaprevir/BMS-791325). Study populations include non-cirrhotic naïve, cirrhotic naïve and previously treated patients. The 3DAA Regimen is being studied as a fixed-dose-combination treatment with twice daily dosing.
Twice daily dosing is a problem (the presence of three drugs rather than only two could be a problem as well from a side effect standpoint).
Adherence to/compliance with an antiviral regimen is critical both to attaining a cure and to minimizing development of resistant strains; a number of people will not reliably take a pill twice a day for one week, much less many weeks. In contrast, the pending Gilead combo of sofosbuvir + ledipasvir is going to be taken as one dosage form, once a day to my knowledge. All else being equal, doctors will prescribe an antiviral that is once-daily instead of twice daily. Bristol-Myers should be congratulated for advancing the art of anti-hep C treatment in Japan, but I continue to believe that Gilead is likely to remain the global leader in treating hepatitis C.
I have previously compared Gilead's Sovaldi and the pending combo with what is known about AbbVie's (NYSE:ABBV) pending regimen, and continue not to be afraid of what AbbVie has pending. The fourth known, pending competitor in the hep C space is Merck (NYSE:MRK), which recently felt it was a good idea to beef up its hep C pipeline by buying Idenix (NASDAQ:IDIX). Merck is late to this party.
Overall, I think that recent events are fine for Gilead's hep C franchise. The CEO thinks so, too, commenting last month at a Wells Fargo conference in an exchange with the lead analyst:
Brian Abrahams - Wells Fargo Securities
Good. Shifting gears to hepatitis C, what's your view on how this Sovaldi launch has gone thus far, and where are you with respect to your efforts to really broaden your reach across different tiers of prescribing clinicians at this point now that we are kind of almost at the middle of the year with Sovaldi?
John Martin - Chairman and Chief Executive Officer
Yes, it's going really well. The one - I mean, everyone knows it's going well...
Brian Abrahams - Wells Fargo Securities
It's remarkable, and the data is obviously incredible.
This interchange is music to GILD stockholders' ears.
If you own GILD stock, you knew that. Mr. Martin also revealed that it took a controversial CEO decision to add on to a pivotal study the arm of the study that allowed Sovaldi to be by far the most successful new drug product launch ever, by dollars. Here is the quote from Mr. Martin:
The one study that we did there is a lot of internal debate, the three months study, where we used Sofosbuvir plus peg/riba for genotype 1. There is (ed: was) internal debate (ed: that) no one is going to use it. And we have decided well (ed: we) should have, because there is going to be that window there where people if they don't have this option won't have access to care. And it wouldn't be a question of warehousing, there just wouldn't be the right option for them. And it turns out 70% of our use is [peg] [ph] regimen and we correctly recognized that three months of interferon in this window time would be acceptable that it has certainly made this - that small study that was a single-arm study has made this market this year much larger than it otherwise would have been. (Emphasis added)
This again speaks to strong management decision-making.
Kudos are in order to Gilead for spending the extra money to study Sovaldi with interferon for genotype 1. That one extra arm of the study has helped a lot of patients as well as, obviously, shareholders.
With all the focus on hepatitis C, it's important to remember that Gilead says that its Viread is the world's leading stand-alone product to treat the incurable hepatitis B, which is discussed next.
Hepatitis B: A week before the Wells Fargo conference, Gilead's president and COO, John Milligan, spoke at a William Blair conference. In his overview, he briefly mentioned a topic that I had not focused on, saying:
We have treatments for hepatitis B including things that stimulates the innate or adaptive immunity and with HBV, we look to convert this from chronic care into a care (Ed: cure) like we have for HCV and are embarking on many programs through that. (Emphasis added)
Commenting in public on a cure for hepatitis B may suggest that something positive has been found in research. Gilead's pipeline presentation on its website mentions both a phase 2 and a different phase 1 program for hepatitis B. The hep B virus has a different "life cycle" (quotes because viruses are not living) than the hep C virus which has made it incurable until now. Gilead is going after hep B with immunotherapy. I'm encouraged by Mr. Milligan's comments in this regard. If Gilead can actually cure a number of patients with this disease safely, humanity and GILD shareholders will both be richly rewarded.
Anti-HIV portfolio, TAF and TDF: A key part of the bullish case on GILD that is not talked about a lot these days is the refreshment of its anti-HIV product line, and of Viread, which as a mono-agent is used for hepatitis B. In the Wells Fargo conference, Mr. Martin provided additional color about Gilead's strategy. Viread has tenofovir as its active ingredient in a chemical form called TDF. The dose of TDF is 300 mg, both in Viread and in Gilead's anti-HIV combination products. A much more potent version of tenofovir known as TAF is in late-stage testing. The TAF doses range from 10-25 mg. Gilead's strategy is, I suspect, going to be to introduce TAF as safer than Viread and price the "new Viread" and the combinations below current prices.
Gilead management hopes to show in Phase 3 trials that unlike TDF, the newer TAF lacks harmful kidney or bone side effects. I do not think management is certain yet about TAF's advantages over TDF other than potency, and is waiting the extensive Phase 3 studies. Gilead has disclosed that 1 million people in developed countries and 6 million elsewhere are taking TDF either as Viread or in combination for HIV.
Gilead desires to get its TAF products on the market before its U.S. TDF patents expire in July, 2017. The lower dose TAF may eventually allow other drugs to be co-formulated with it in one pill, and the greatly diminished use of an expensive chemical will allow greater numbers of patients to be treated worldwide given a lower cost of goods. So, this is a very important line extension, and gradually Gilead is telling us more and more about this program. One way or another, I expect that TAF-based products will pass muster with the FDA and be successes. How much market share generics to Viread and the current anti-HIV combos obtain will be very important to learn.
Idelalisib: In 2011, Gilead acquired Calistoga Pharmceuticals, giving it control of CAL-101, which then became GS-1101, now called idelalisib. The story of Gilead's acquisition of Calistoga supports the thesis that Gilead is special. From a contemporaneous account in early 2011:
Calistoga Hands the Keys to Gilead, Bets It Can Make Cancer a Chronic Disease Like HIV
Calistoga Pharmaceuticals CEO Carol Gallagher was playing with a strong hand of cards, holding onto an emerging cancer drug she could have sold for a mint to any number of Big Pharma companies hungry for innovative new products.
But she and Calistoga's board took an unusual tack, selling the Seattle-based company for as much as $600 million to an HIV drug powerhouse that's still a newbie to the cancer drug business-Gilead Sciences (NASDAQ: GILD).
While Gilead may not have the experience of a Pfizer, Roche, or Novartis in cancer, it sees the cancer drug landscape evolving into something right up Gilead's alley, Gallagher says. The vision is that a cancer diagnosis will become less like a short-term death sentence, and more of a chronic disease that must be managed regularly, like HIV. As DNA sequencing gets fast and cheap enough for many more doctors to see what's going wrong at a molecular level, patients will be treated with cocktails of drugs aimed at specific molecular targets, through convenient oral pills, that offer mild side effects compared to chemotherapy, says Gilead's chief scientific officer, Norbert Bischofberger. Calistoga's drug candidates fit right into this vision, he says.
I have been reviewing the clinical data on idelalisib and think that its commercial potential may not be fully appreciated by investors. Next month, the FDA is set to rule on it to treat relapsed chronic lymphocytic leukemia. This approval appears very likely, based on Phase 3 data. It has Breakthrough Therapy designation from FDA. Once approved, the product will compete with Imbruvica (ibrutinib), which Pharmacyclics (NASDAQ:PCYC) developed and on which it is partnering with Johnson & Johnson (NYSE:JNJ) in the U.S., with JNJ handling the product abroad. Idelalisib and ibrutinib are both oral drug products that affect the internal protein cascades found in malignant B cells. They represent a new, non-chemotherapy paradigm in treatment of CLL and non-Hodgkin's lymphomas.
What may be less appreciated is the potential that idelalisib has in the rest of the lymphoma spectrum. Gilead has submitted an NDA for it for a broad spectrum of non-Hodgkin lymphomas based on an open-label (non-placebo controlled) phase 2 study. The results were strong, as the European Society for Medical Oncology summarized:
Idelalisib in Relapsed Indolent Lymphoma A promise from PI3Kδ targeting in B-cell malignancies
In 13 March 2014 issue of the New England Journal of Medicine, Dr Ajay Gopal of the Division of Medical Oncology, University of Washington School of Medicine, Seattle Cancer Care Alliance, USA and colleagues reported results from an international non-randomised phase II study of idelalisib monotherapy in patients with indolent non-Hodgkin's lymphoma. The overall response rate was impressive 57%, with a median progression-free survival of 11 months, values suggesting that the efficacy of idelalisib is similar or superior to those of other active treatment options in relapsed or refractory indolent non-Hodgkin's lymphoma. The toxic effects were acceptable with common adverse events including diarrhoea and aminotransferase elevations that were mostly reversible on dose discontinuation or reduction.
Indolent cases constitute approximately one third of all patients with non-Hodgkin's lymphoma and include follicular lymphoma, small lymphocytic lymphoma, marginal-zone lymphoma, and lymphoplasmacytic lymphoma with or without Waldenström's macroglobulinemia.
Similar positive sentiments were reported by the investigators and expert commentators in the NEJM, as well.
Idelalisib has immense potential, but right now this is only potential. We can even think of quantifying this potential, with the FDA yet to rule and with competitive products from strong companies presumably coming sooner rather than later.
Eventually, I believe that Imbruvica and idelalisib may be given daily to CLL patients and other patients suffering B-cell malignancies as first line therapy. If so, the commercial potential is enormous. (Note that I am long a modest amount of PCYC.)
Let's move on from product developments to the numbers.
EPS: Earnings estimates have been creeping up for all time periods I can find. I have no idea what whisper numbers are circulating, and GILD is no longer cheap, as I thought it was after it announced the blow-out Q1 earnings. Consensus is for $1.64 for Q2 and about $6.35 for this year. GILD is trading at around 10X consensus EPS estimates for 2016. If one thinks the pipeline is relatively weak and that competition and "too many" cures are going to drag hepatitis C sales downward starting around then, then GILD may look unattractive at its current price around $89.
There is good news in my view on that issue, in that two well-known independent analytic companies have the following take on GILD's fair value.
Valuing GILD: Gilead is in transition, has an aggressive R&D program, and does not lack for competition, including generic competition down the road for its products, especially Viread and the anti-HIV portfolio.
One of the independent analytic outfits I pay attention to is Standard & Poor's, which has rationalized its stock rating division into what it now calls S&P Capital IQ. S&P has a $130 one-year price target on GILD. Separately, it uses a proprietary methodology to produce a fair value estimate of $180 per share. This is the largest premium to trading value I have seen in any such fair value estimate by them. There's no way to know if they are right, of course, but many companies are judged by them to be trading at or above fair value. Thus, at least, they lack an ingrained over-bullish bias.
Another indie is Value Line. It sees GILD trading around $145 in 3-5 years. Value Line projects about $8 per share in cash flow for 2015. Its analysts peg fair value, i.e. the "value line" itself, at 20X cash flow - almost all of which is free cash flow. This simple valuation measure would suggest that a reasonable trading price in one year would be around $160 per share if consensus estimates are met and the company is otherwise perceived to be on track. Given its history of rapid growth, existing products and growth potential, should GILD trade at a 5% free cash flow yield? That is a key question that investors may wish to think about.
My own sense is that in a conservatively-valued stock market, GILD would be an average (interesting) stock. However, many stocks are at higher valuations than GILD with worse apparent risk versus reward considerations. Thus I am comfortable being overweight GILD with the idea that it is relatively cheap in a rich market.
All the many company-specific and general market risks that one can think of are present with an investment in GILD. I think we all understand that this is a growth stock, not a boring electric utility or Big Pharma name such as Pfizer (NYSE:PFE).
Summary: As we await the sales and earnings numbers in less than two weeks, we may wish to remember that what we will learn will already be historical and may not tell us all that much about Gilead's intermediate-to-long term earnings power.
GILD is a good deal more than a hepatitis C company with legacy anti-HIV products. In addition to idelalisib, it has a number of important drugs and drug combos in its pipeline that were not discussed here; I did review several of them previously.
I would urge anyone seriously invested in GILD or considering it to consider its non-hep C existing products and the pipeline it has disclosed.
In conclusion, my view of Gilead is that it could continue to strongly outperform the market and could even become one of the most highly-valued companies on earth. It is innovative and focused, and it operates in a great business niche. It may be poised to deliver strong financial results for the imaginable future. At the same time, its operational strengths and relatively low forward P/E can provide important downside protection in the event of bad news, whether company-specific or due to a change to outright bearish market conditions. As usual, with opportunity comes risk, and many adverse events could arise to negatively affect this bullish case.
Disclosure: The author is long GILD, PCYC. 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.
Additional disclosure: Not investment advice. I am not an investment adviser.