A loss for Gilead (NASDAQ:GILD). Investors in the company shouldn't try to hide behind a veil of denial, but this is what the Hep C lawsuit that Merck (NYSE:MRK) brought against Gilead amounts to, a loss for Gilead. Not only did Merck attack Gilead on the product substitute front, but they are also attacking the company on the barrier to entry front.
Gilead has a pretty high wall around its castle by from the product substitution front because they were in the market with Harvoni and Sovaldi first and they are both names that physicians trust. It may take a while for Merck's Zepatier to erode Harvoni and Sovaldi sales, but Merck is also asking for a 10% royalty payment on Harvoni and Sovaldi sales going forward.
At least one patent from Merck has been deemed valid within this case against Gilead. The very next trading day after the news (23Mar16) saw Merck shares "jump" 0.09% (remember this was on a day where the S&P 500 was down 0.64%) and Gilead shares drop 3.88%. Gilead came into March like a lion having moved up to the tune of 7.4% but is now only up 3.2%.
This is definitely an uppercut on Gilead's chin that Merck has landed. Let's not kid ourselves here, Harvoni and Sovaldi make up roughly $4.9B worth of sales for Gilead, amounting to nearly 58% of total revenues. We are talking about the majority of the company's revenues in jeopardy here. The Hep C franchise is definitely a fading asset on the company now.
Segment Revenues (millions)
For those that believe this is going to be a long, drawn out battle in court, please remember that lawyers aren't free. Those lawyer fees can definitely eat away at retained earnings which should be used for future share buybacks or dividends.
Bulls will argue that valuation is still extremely inexpensive at just 7.2x next year's earnings estimates of $12.44, but I believe that when a stock is trading so cheaply that it might be this is the best it is going to get. Gilead has almost no earnings growth expectations with a short-term outlook of 1.8% increase in earnings and a five year outlook of 5.3%. Just take a look at General Motors (NYSE:GM) over the past couple of years, it constantly trades at valuations below 6x forward earnings estimates and it has just been a sinking ship since it started issuing a dividend in 2014.
Chart of Gilead's stock price since issuing a dividend.
Chart of GM's stock price since issuing a dividend.
Just take a look at how eerily familiar the two graphs are that I displayed above. Now forget for a moment that I told you which chart belonged to which company. If I told you that each of these charts represented the stock of a company that offers a product to which not every human needs, has huge lawsuits against them, and whose products are expensive, wouldn't you say that each chart has the correct looking trajectory?
Now from a technical perspective Gilead's stock closed out at $93.72 the day the announcement was made and the stock gapped lower to $90.08 the following day. The silver lining is that the gap down was made on slightly higher than average volume, 13.9M shares traded hands the day after the news with average volume hovering at 12.1M shares. This tells me that the big boys aren't really too concerned about the problem that Gilead faces. If we begin to see the stock close that gap back up to the $94 dollar level then I think that signals the coast is clear to buy the stock again for just the short-term basis.
Now before you go and call me a bear on the name, let's get it straight, I'm a realist by wanting to know my risks in an investment. I personally haven't bought the stock since earlier this month and don't look to any time soon with this bit of news that came out. But if it does close that gap of $94 as I spoke about in the previous paragraph I will have to take another look at the name only on a short-term basis. I will instead look to funnel my Gilead funds into Allergan (NYSE:AGN) at this point in time because that stock is trading below its buyout price by roughly 15%.
Disclaimer: This article is in no way a recommendation to buy or sell any stock mentioned. This article is meant to serve as a journal for myself as to the rationale of why I bought/sold this stock when I look back on it in the future. These are only my personal opinions and you should do your own homework. Only you are responsible for what you trade and happy investing!
Disclosure: I am/we are long GILD, AGN.
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.