The Market Is Essentially Valuing Gilead's HCV Business At $0

| About: Gilead Sciences, (GILD)

Summary

The market is severely discounting Gilead's HCV business.

Gilead's non-HCV business has a fair value near the current price.

There are still risks in Gilead's business and a way to hedge those risks is to consider put options.

The market has been punishing Gilead Sciences (NASDAQ:GILD) ever since their recent earnings report where revenues came in light because of slowing Harvoni and Sovaldi sales. In addition, EPS would have been nearly inline were it not for a $200 million charge that Gilead had to take for its legal case with Merck (NYSE:MRK). While everyone always focuses on the HCV segment, I will show that more focus should be on its other products because those products are growing.

Valuing Non-HCV Gilead

To value Gilead without its HCV business, I first looked at sales of Harvoni and Sovaldi Gilead reported recently and found that those two products account for nearly 56% of revenues. That means just over 44% of revenues comes from other sources, therefore I applied that percentage to TTM free cash flows, which provided me with an estimated level of free cash flows that comes from Gilead's non-HCV products.

Harvoni Q1 2016 Sales

$3017

Sovaldi Q1 2016 Sales

$1277

Harvoni +Sovaldi Q1 Sales

$4294

Total Q1 2016 GILD Sales

$7681

Harvoni +Sovaldi Q1 2016 % of Revs

55.90%

Other Products Q1 2016 % of Revs

44.10%

TTM FCF

$17741

Other Products FCF [TTM FCF* Other Products % of Rev]

$7823.04

Shares

1412

FCF/Share

$5.54

Click to enlarge

[Table data from Gilead 1Q 2016 earnings report & Gurufocus]

The next step of the process to was to calculate the growth rate to use in my valuation section below. I went to the last two first quarter earnings releases to compile the data in the table below for each non-HCV product or category that Gilead has. As you can see, revenue from non-HCV products grew over 18% in the last year and just under 10% last year. For the purposes of my valuation calculation, I used an average of the two growth rates.

Non HCV Product Sales

2016 Q1

2015 Q1

2014 Q1

Truvada

$898

$771

$760

Atripla

$675

$734

$780

Stribild

$477

$356

$215

Complera / Eviplera

$381

$320

$251

Viread

$272

$234

$211

Genvoya

$158

$0

$0

Other Antiviral

$28

$22

$18

Other Products

$498

$417

$362

Total

$3387

$2854

$2597

% Growth

18.68%

9.90%

Average Growth Rate

14.29%

Click to enlarge

[Table data from Gilead 1Q 2016 & 1Q 2015 earnings report]

Valuation

To determine the fair value for Gilead's non-HCV business, I conducted a discounted cash flow analysis (table below) and found that shares are undervalued at current levels. I used FCF data from the first table above, growth data from the second table above and to determine the discount rate & terminal growth rate, I used the following calculators. As you can see in the table below, the value of Gilead's non-HCV business is just under 5% below the current stock price. If that is the value of Gilead's non-HCV business, then that shows the market is essentially valuing Gilead's HCV business and pipeline at $0.

Discount rate calculator

Terminal Growth calculator

  • FCF/Share: $5.54
  • Proj. Long-term growth rate: 14.29%
  • Terminal growth rate: 0.38%
  • Discount rate: 8.53%

Fair Value Calculator Assumptions

  • Free Cash flow grows for next 5 years.
  • After that, growth levels off to the terminal rate for 15 years.

GILD Non-HCV

DCF Calculations

CF/Share

PV

Year 1

1

6.33

$5.83

Year 2

2

7.24

$6.14

Year 3

3

8.27

$6.47

Year 4

4

9.45

$6.81

Year 5

5

10.80

$7.18

Year 6

6

10.84

$6.64

Year 7

7

10.89

$6.14

Year 8

8

10.93

$5.68

Year 9

9

10.97

$5.25

Year 10

10

11.01

$4.86

Year 11

11

11.05

$4.49

Year 12

12

11.09

$4.15

Year 13

13

11.14

$3.84

Year 14

14

11.18

$3.55

Year 15

15

11.22

$3.29

Year 16

16

11.26

$3.04

Year 17

17

11.31

$2.81

Year 18

18

11.35

$2.60

Year 19

19

11.39

$2.41

Year 20

20

11.44

$2.22

Years 1-5 Growth Value

$32.44

Terminal Growth Value

$60.97

Less Long-Term Debt/share

$14.93

Value

$78.48

Current Price

$82.14

Upside/Downside

-4.45%

Click to enlarge

Closing Thoughts

In closing, I believe Gilead is worth considering at these levels given the market is essentially discounting their entire HCV business and pipeline. With important developments like a pan-genotype HCV treatment and numerous other products in the pipeline that are in phase 3 development. In addition, long-term Gilead has a number of partnerships that could pay off as well, like its partnership with Galapagos (NASDAQ:GLPG) on its Rheumatoid Arthritis and Crohn's disease candidate. Investors also receive a dividend that was recently increased dividend and Gilead is still repurchasing large quantities of stock lowering their share count.

As I have repeatedly noted in previous articles, there are risks in Gilead's business, mainly coming from political pressure about drug pricing. The legal pressure on Gilead has subsided after its case with Merck was reopened giving investors a new outlook that Gilead might not to have to pay any penalty. I have noted repeatedly that a way for investors who own shares or considering owning shares is to buy put options that are dated after the election.

For example, my article on Gilead on December 4th where I had the idea of buying puts to protect a long position has proved to be a good strategy. As you can see in the table below, by using put options to protect a position you would be much better off than just owning the stock. By using this strategy, existing or potential investors can sit back and ignore the noise of bearish authors who will try to find any little item to try to bring Gilead down. Investors can also enjoy the 2.27% dividend yield, large share buyback and the knowledge that numerous HCV patients are being cured daily by a best in class product.

On Dec 4th 2015

Shares/Contracts

Cost per Share/Contract

Value

Total

Stock

100

$104.07

$10,407

$11,582

Put Option

1

$1,175

$1,175

Current

Shares/Contracts

Cost per Share/Contract

Value

Total

Stock

100

$82.14

$8,214

$10,360

Put Option

1

$2,060

$2,060

Dividends Collected

$86

% Change W/Put Option

-10.55%

% Change W/O Put

-20.25%

IBB % Change

-21.95%

Click to enlarge

[Table data from ThinkorSwim platform]

Disclaimer: See here.

Disclosure: I am/we are long GILD.

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.