In the past, I have made it clear that I am a biopharma bull. What particularly attracts me to the sector is the takeover activity and the irrational level of risk discounting. Gilead (GILD), which bought out Pharmasset for $11 billion, now has a powerful hepatitis C drug in its pipeline. Pharmasset PSI-7977 is expected to begin Phase III trials in the second half of 2012, which will help unlock the discount to intrinsic value.
In this article, I will run you through my DCF model on Gilead and then triangulate the results with an exit multiple calculation and a review of the fundamentals compared to Pfizer (PFE) and Johnson & Johnson (JNJ). I remain highly bullish on both Pfizer and Gilead.
First, let's begin with an assumption about the top line. Gilead finished FY2011 with $8.4 billion in revenue, which represented a 5.5% gain off of the preceding year: deceleration. I model a 5% per annum growth rate over the next half decade or so. This, I feel, is a conservative input, since biotech catalysts typically yield double-digit returns over this time period.
Moving onto the cost side of the equation, there are several items to consider: operating expenses, capital expenditures, and taxes. I model cost of goods sold eating 24% of revenue vs. 13.5% for SG&A, 13% for SG&A, and 2% for capex. Taxes are estimated at 27% of adjusted EBIT (i.e., excluding non-cash depreciation charges to keep this a pure operating model).
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 10% yields a fair value figure of $61.84, implying 32.5% upside.
All of this falls within the context of an impressive year:
Our team's hard work over the last several years resulted in many significant financial, commercial and R&D milestones in 2011. We saw record revenues for ATRIPLA, Truvada, AmBisome, Ranexa, Letairis and Cayston. We also achieved record market share for our combined HIV portfolio as well as our cardiopulmonary products.
From a multiples perspective, Gilead is equally attractive. It trades at a respective 13.2 times and 10.7 times past and forward earnings vs. 20.3 times and 9.5 times for Pfizer and 18.5 times and 11.8 times for J&J. Assuming a multiple of 13.5 times and a conservative 2013 EPS of $4.30, the stock would hit $58.05 -- roughly in line with my DCF result.
Consensus estimates for Pfizer's EPS forecast that it will decline by 1.7% to $2.27 in 2012 and then grow by 3.5% and 3.8% in the following two years. Assuming a multiple of 13.5 times and a conservative 2013 EPS of $2.31, the stock would hit $31.19 for 39.8% upside. According to NASDAQ, analysts are bullish about the stock and rate it near a "strong buy. Many individuals scorn the company for its weak pipeline and patent cliffs; however, I believe this has set the bar awfully low. If Pfizer just grows 2.8% annually and keeps operating metrics unchanged, the stock still is worth north of $30. Growth of 2.8% is what you would expect for perpetuity, not for the immediate future.
Consensus estimates for Johnson & Johnson's EPS forecast that it will grow by 2.4% to $5.12 in 2012 and then by 6.3% and 9% in the following two years. Assuming a multiple of 13.5 times and a conservative 2013 EPS of $5.38, the stock would hit $72.63 for 13.1% upside. I would not be surprised if the company decides to separate its consumer business from its pharmaceutical business. Given the extent to which the bears are discounting pharmaceuticals, this is causing an irrational drag on the consumer segment. Some sort of strategic split could allow for improved efficiency is risk allocation. In the meanwhile, I recommend holding out on the company.