Gilead: Estimates Too High, But Valuation Too Attractive As A Buyout Candidate

| About: Gilead Sciences, (GILD)

Summary

Gilead's EPS will likely decline in the 2016-2019 period to a level below consensus forecast. However, even at an EPS of $8, the stock trades at only a 9x P/E.

Gilead's near-term pipeline has been meaningfully reduced due to recent discontinuations, thereby placing greater emphasis on the need for product acquisitions.

Gilead made two successful, transformative deals in the past, namely its entry into HIV and HCV therapeutics. Management seems reluctant currently to step up to the plate a third time.

Gilead's effort in NASH is very promising, but a drug approval for this disease will not have a significant impact until next decade.

A larger pharmaceutical company with an interest in hepatology would be well served to acquire Gilead. I estimate the price would be in the $100-110 range.

Gilead (NASDAQ:GILD) needs to make a transformative acquisition (or a series of smaller ones) in order to grow earnings in the 2016-2019 time frame. The rationale is quite simple. The cost of HCV pharmacotherapy in the US declined by over 40% INTRA-YEAR in 2015, driven largely by the introduction of competing regimens. Even with growth in its HIV franchise and HCV sales overseas, Gilead could not overcome the reduction in highly profitable US HCV revenues in 2016.

Looking ahead, 2017 appears challenging based on the likelihood of fewer patients treated for HCV in the US and competitive challenges. The same situation should play out in 2018 and 2019. This reflects the fact that the initial bolus of warehoused patients and many of those with more advanced disease have been treated.

In the meantime, Gilead's near-term pipeline is devoid of meaningful products (late stage assets simtuzumab, momelotonib, GS-5745, GS-4774 and GS-4997 for PAH and DKD indications have been relegated to the drug graveyard) and its effort in developing an oncology franchise has not been successful. I remain positively inclined toward its effort in NASH, but this is several years away from contributing meaningfully.

I am forecasting Gilead's EPS to decline to $8 in 2019, significantly less than the consensus estimate of $10.65. However, even at that projection, the stock would be selling for a P/E of 9x with a 2.5% yield. It therefore appears that downside, even with analyst estimate reductions, is limited. Management has stated its unwillingness to expand its product line through acquisition unless it sees long-term value.

While I agree with that philosophy, I believe that it points to a failure to identify appropriate candidates, which seem to be quite prevalent. Given Gilead's stock valuation, I remain surprised that one of the higher capitalization pharmaceutical companies has not targeted it for a merger, as the accretion to earnings would be meaningful. I would expect a takeover price to be in the $100-110 range. Alternatively, given the cash flow and conservative valuation, Gilead should generate interest from activist investors as earnings estimates are reduced.

In conclusion, Gilead has been remarkably successful in transforming itself from an antisense company to a leader in HIV and HCV therapeutics. Its effort in oncology has been unsuccessful, and it has recently discontinued several key late stage pipeline candidates. Management seems reluctant at the current time to augment its drug portfolio through acquisition, thereby, in my opinion, guaranteeing several years of declining earnings.

I am hard pressed to believe that investors will remain patient as this scenario unfolds over the next three years. On the other hand, the company generates impressive cash flow and the stock, even at my EPS forecast, is not expensive. This analysis suggests that something "has to give" in the near future.

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.