Gilead Sciences Inc. (NASDAQ:GILD) is a bargain at these prices. Currently, the stock is trading at ~33% below its 52-week high, and the major difference is that it's now way underpriced, but with stronger fundamentals. The mean price target of Wall Street analysts for the company is at $123/share, or 48% upside, and the low price target is $100/share, or ~20% upside.
When you look at the direct competition comparison (as of 2014 fiscal year results), Gilead Sciences is very efficient. I say this because its EBITDA, Net Income and EPS are way above that of peers, despite the fact that some of its peers such as Pfizer Inc. (NYSE:PFE) and Roche Holdings AG (OTCQX:RHHBY) have north of 50% higher revenues than the company has.
Pricing can undergo different stages of evolution, and Gilead's major drugs under scrutiny - Harvoni and Solvadi - are going through the same process. It first started as a premium product because it was rare, people needed it and it had no competition. In this case, companies make money from high prices and high margins. But once competition steps in, Gilead can now move towards competitive pricing, better quality and higher volumes. In either case, the margins can still be good. Gilead's drug are not reaching everyone with hepatitis C. With competitive pricing, the company can still see growth through increased volume.
So, the most logic question is, why a seemly bearish title for a company I am obviously bullish on?
The answer is because Gilead's stock price has not yet stabilized. There will be a lot of tailwinds as the market attempts to price in all the political headline risk (at both the state and national levels), the growing Pharmacy Benefit Manager (PBM) leverage and the new competition in the company's stronghold.
Because of these inevitable tailwinds, it likely that even if Gilead outperforms and beat estimates this coming week, the street will likely under-appreciate. But if it misses or offers weak guidance for 2016, the stock will likely be over-punished.
National and State Political Headwinds
The political headline risk is not going to be a week's headwind and everything goes back to normal - ask Valeant Pharmaceuticals (NYSE:VRX) and its investors. In a CNBC interview, Maura Healey, Massachusetts Attorney General, raised the issue of why drug companies (particularly Gilead Sciences) should not be allowed to bankrupt states. Some of the points she raised were:
- Last year, Gilead Sciences' hepatitis C drug only reached 2% of the people who actually needed it. ~3.2 million Americans have hepatitis C. Four out of 5 people have no initial symptoms. Most people do not have access to the drugs.
- Gilead Sciences' pricing raises questions because it is priced knowing that most people cannot have access to it. 70% of those with hepatitis C develop chronic infections, liver cirrhosis or liver cancer.
- The company prices its drugs cheaper in other countries - Egypt was used as an example. Gilead prices Solvadi at $84,000 in the United States, compared to $900 in Egypt.
It is going to take months for such headline risk to be less impactful on the company's stock price. Moreover, the upcoming presidential elections are going to worsen the impact of such headline risk, making it even harder for the stock to recover and stabilize. This is because medical care is an issue that resonates with anyone in the United States who is affected by rising medical costs. In the last 12 years, the cost of living in the U.S has outpaced income growth. This increased cost structure has mainly been caused by the 51% increase in medical costs and the 37% increase in food and beverage prices.
Any tactical politician will have to capitalize on this momentum, and pharmaceutical companies will be the targets - Gilead is already in the spotlight. Both Democratic and Republican front-runners have raised the issue. Donald Trump recently took a stab at the drug industry. As did Hillary Clinton:
"This is predatory pricing. It is unjustified. It is wrong."
Eventually, drug companies will seriously start considering their pricing structure.
Emergence of Cheaper Competitors and The Growing Power of PBMs
In addition, another pressing issue is that of potential margin compressions from increased competition. Merck & Co., Inc. (NYSE:MRK) priced its newly FDA-approved hepatitis c drug at more than 30% discount to Solvadi and Harvoni from Gilead Sciences and Viekira Pak and Technivie from AbbVie Inc. (NYSE:ABBV). According to TheStreet, with data gathered from the Wall Street Journal and Bernstein, Merck could serve ~11% of the market in 2017 with roughly $2.2 billion in sales.
"While Merck's US label for their HCV agent is clearly inferior to incumbent competitors, we expect the launch of Zepatier to further drive net price reductions for the all market participants,"
Gilead Sciences' drugs are still superior in terms of quality, but because they are expensive and PBMs now make decisions on behalf of people's health, the Merck and AbbVie combo is a huge hindrance to any potential margin expansions for Gilead moving forward. It will force the company to be on the defensive and start aggressively competing on prices. PBMs are going to make it even harder for Gilead Sciences.
Take the AbbVie and Express Scripts (NASDAQ:ESRX) deal, for example. Express Scripts signed an exclusive deal with AbbVie, making AbbVie's hepatitis c drug, Viekira Pak, its exclusive option.
"Pharmaceutical innovation must be rewarded based on the value it brings to patients and payers. This agreement marks a fundamental change in how sustainable access and affordability will be delivered to hepatitis C patients."
- Express Scripts chief medical officer, Steven Miller, in a press release
This deal raised a lot of concern over patient choice, because Gilead Sciences' hepatitis C drugs are superior, but patients will be forced to settle for the second best on something as critical as healthcare. Viekira Pak's inferiority to Solvadi and Harvoni was strengthened by an FDA warning in October 2015 that Viekira Pak and Technivie "can cause serious liver injury mostly with underlying advanced liver disease." This power PBMs have over patients enables them to negotiate for lower prices from drug companies, and because PBMs serve a lot people, they have incredible leverage in negotiating drug prices with drug companies. Consequently, with the third competitor on the market, hepatitis c drug companies might see further margin compression.
Lastly, drug companies will have a lot of headwinds for 2016. Medical costs are rising faster than income. The cost of drugs is an emotionally driven issue that any tactical politician should address to resonate with the masses. It is a political tailwind that is going to cause headline risk throughout the year. The rationale is well founded. Why should Americans subsidize other countries' cost of drugs?
Normally, the market can easily price tailwinds that are certain. For instance, when Viekira Pak first came into the picture, the market easily adjusted Gilead's stock price to reflect that. In a couple of weeks, the market can also price in the potential effect of Merck's Zepatier on Gilead's revenues moving forward. But the Massachusetts inquiry and the presidential headwinds are still ongoing. The company's future profit margins hinge on whether or not the government will actively cripple its pricing power, or whether the PBMs' leverage significantly increases in light of a third competitor or whether Gilead Sciences will significantly cut prices to match the competition. It is these ongoing critical headwinds that pose more volatility in Gilead's stock price.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.