Why Gilead Is A Better Buy Than This Rival

Jul.24.14 | About: Celgene Corporation (CELG)

Summary

We pitch two companies from the biotechnology sector, Gilead and Celgene, against one another in the latest installment of our Head-To-Head series.

The article focuses on the relative strengths and weaknesses of Gilead and Celgene, based on business performance and sustainability/dividends/forecasts.

It ends with discussion of the current valuations of the two companies, and details whether Gilead represents good relative value at current price levels.

Gilead Background

Gilead (NASDAQ:GILD) is a biopharmaceutical company that discovers, develops, and commercializes medicines for the treatment of life-threatening diseases in North America, South America, Europe, and the Asia-Pacific. The company's treatments include that of Human Immunodeficiency Virus (HIV) infection in adults, as well as products for the treatment of liver disease. It also offers Letairis, an endothelin receptor antagonist for the treatment of pulmonary arterial hypertension; Ranexa, a tablet used for the treatment of chronic angina; the Lexiscan/Rapiscan injection for use as a pharmacologic stress agent in radionuclide myocardial perfusion imaging; Cayston, an inhaled antibiotic for the treatment of respiratory systems in cystic fibrosis patients; and Tamiflu, an oral antiviral capsule for the treatment and prevention of influenza A and B.

Team Money Research Rating

Our investment philosophy is to focus on company fundamentals and identify stocks that are displaying strong business performance, that operate sustainably and that pay a decent, well-covered dividend.

We analyze each company relative to the other on the following criteria within each of our two main buckets:

Business Performance

  1. Return on equity
  2. Return on assets
  3. Operating margins

Sustainability/Dividends/Forecasts

  1. Debt-to-equity ratio
  2. Interest cover
  3. Dividend payout ratio
  4. Forward yield
  5. Annual EPS growth forecast

Once we have analyzed the two companies based on the first two buckets, we can then assess whether they represent good value based on the current prices of the two stocks. We use the following criteria to assess valuations on a relative basis.

Valuation

  1. Forward price-to-earnings ratio
  2. Price-to-book value ratio
  3. Enterprise value-to-EBITDA
  4. Price to 3-year average free cash flow ratio
  5. 5-year price-to-earnings growth ratio

So, for example, a company that performs well compared to its rival on the first two buckets (business performance and sustainability/dividends/forecasts) and that is undervalued relative to its peer (based on the third bucket: valuation) could outperform its competitor going forward.

The table below provides the data that we will use to analyze Gilead and Celgene (NASDAQ:CELG) for the first two buckets.

Stock

Gilead

Celgene

Business Performance

Return on equity

37.80%

26.79%

Return on assets

16.26%

9.59%

Operating margins

47.86%

27.42%

Sustainability/Dividends/Forecast

Debt-to-equity ratio

71.31%

114.74%

Interest cover

39.66

12.34

Dividend payout ratio

N/A

N/A

Forward dividend yield

N/A

N/A

Annual EPS growth forecast

22.14%

31.61%

Click to enlarge

The results from our first bucket: business performance shows that both companies are highly profitable. However, Gilead offers investors better return on equity and return on asset numbers than Celgene, with its operating margins also being ahead of its sector peer. Indeed, while we're impressed with Celgene's profitability, with return on equity being 26.79% and return on assets being 9.59%, Gilead delivers a stronger performance. Indeed, its return on assets is 16.26% and its return on equity is 37.80% -- well ahead of that of Celgene. In addition, Gilead's operating margins of 47.86% are significantly higher than Celgene's 27.42%.

However, what really impresses us about Gilead's return on equity is the fact that it is higher than that of Celgene, despite the company having a lower debt-to-equity ratio than its rival. For instance, Gilead's debt-to-equity ratio is only moderate at 71.31%, while Celgene's is much higher at 114.74%. This makes Gilead's better return on equity seem even more impressive, since its profitability has not experienced the same boost from debt financing as that of its peer.

Meanwhile, both companies have comfortable interest cover and do not pay a dividend. Their earnings forecasts are highly impressive, with Gilead being edged out by Celgene, since it is expected to deliver EPS that is 31.61% higher next year, versus growth of 22.14% for Gilead.

Overall, we feel that Gilead edges out Celgene on the first two buckets. Although its earnings growth forecast is lower for next year, its higher profitability and lower debt levels mean that its overall performance is slightly better than that of its rival.

Valuation

Due to its outperformance of Celgene in the first two buckets, we would expect Gilead to trade at a slight premium. Let's see if it does.

Stock

Gilead

Celgene

Valuation

Forward price-to-earnings ratio

10.99

18.45

Price-to-book ratio

10.23

15.47

EV/EBITDA

20.14

31.97

PEG

0.48

0.96

Price-to-free cash flow ratio

45.15

37.85

Click to enlarge

We're surprised to see that Gilead offers significantly better value than Celgene on a number of the valuation metrics. Indeed, its forward P/E ratio is 40.4% lower than that of Celgene, while its EV/EBITDA ratio is 33.9% lower. However, what stands out for us in the third bucket: valuation is the difference in the PEG ratios of the two companies. Sure, they are both attractive, at 0.48 for Gilead and 0.96 for Celgene, however Gilead's is currently at a discount of 50% to its rival. For us, this seems far too wide, as do the other ratios (such as price-to-book, P/E and EV/EBITDA) where Gilead is at a discount to Celgene. As such, we feel that Gilead could outperform its sector peer going forward.

Conclusion

Gilead is a high-quality company that posted impressive scores on the Team Money Research Rating System. Its scores edged out sector peer Celgene on the first two buckets and the third bucket: valuation indicates that its current valuation is relatively attractive. As a result, we believe that Gilead could outperform Celgene going forward.

Here's another Head-To-Head article that appeared on Seeking Alpha and that you may find useful. Click here to take a look.

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.