Gilead Sciences: Industry Landscape, Strong Growth Make It a Buy

Originally written on May 7, 2008

Gilead Sciences (GILD) is one of the leading biopharmaceutical companies, providing innovative therapeutics in areas of unmet medical needs. With the mission to advance the care of patients suffering from life-threatening diseases, Gilead discovers, develops and commercializes therapeutics solutions for patients inflicted with HIV, hepatitis B, fungal infection, and pulmonary arterial hypertension [PAH]. It is the dominant leader in the treatment of HIV patients, and has gradually expanded its product portfolio and new product pipeline into other area.

Major Products

GILD’s major products include the following:

• Truvada®, Atripla®, Viread® and Emtriva® for the treatment of HIV (human immunodeficiency virus) infection;
• Hepsera® for the treatment of chronic hepatitis B;
• AmBisome® liposome for injection for the treatment of fungal infection;
• Letairis® for the treatment of pulmonary arterial hypertension (PAH);
• Vistide® for cytomegalovirus infection;
• Flolan® for pulmonary hypertension;
• Tamiflu®, marketed by Roche worldwide under a royalty-paying collaborative agreement with GILD, for the treatment and prevention of influenza;
• Macugen®, marketed by OSI Pharmaceuticals, Inc. under a royalty-paying collaborative agreement with GILD, for the treatment of neovascular age-related macular degeneration.

GILD received in late March 2008 the positive opinion for its Type II variation application to extend the indication for Viread® to treat chronic hepatitis B from European CHMP (Committee for Medicinal Products for Human Use) of the European Medicines Agency [EMEA], and in April, GILD was granted marketing authorization by European Commission in all 27 member states of the European Union. Also in April, GILD obtained the approval to market Viread® for treatment of chronic hepatitis B in New Zealand and Turkey. In addition, Gilead Sciences submitted applications for marketing approval of Viread for hepatitis B in the US, Australia and Canada. Furthermore Gilead has made significant progress in advancing its marketing effort for its drugs for treatment of CF, and pulmonary Pseudomonas aeruginosa infection.

On the new product front, Gilead continues to make progress on new drug development and study of new indication of existing drugs. In 2007, Gilead received consent from FDA on its next generation HIV drug candidate, elvitegravir, a novel integrase inhibitor which is targeting AIDS patients who develop drug resistance, to proceed with phase III clinical trial (more on this new development later). In the cardiovascular area, Gilead is conducting two phase-III clinical studies for the treatment of resistant hypertension, and expects to receive data from these two studies in 2009; Another new development at Gilead is the Phase 1b study of GS9190, a non-nucleoside polymerase inhibitor for hepatitis C patients. Through its active research and development program, Gilead perseveringly works on identifying new and improved compounds for the treatment of HIV/AIDS, chronic hepatitis, respiratory and cardiovascular conditions. Gilead invests heavily in its R&D program, increasing at a rate of over 30% year over year.

Quality Earnings Growth

Gilead’s signature products are drugs treating patients with HIV, which include Truvada, Atripla, Viread and Emtriva. Together they generated $3 billion revenue in 2007 and contribute to over 84% of Gilead’s first quarter revenue in 2008. In the first quarter 2008, Gilead achieved total revenue of $1.14 billion, and the total of its HIV product sales grew 37% to $964.7 million, compared to the sales in the first quarter of 2007. The increase in sales volume of Truvada and Atripla is the driver behind the impressive growth. In the 1st quarter of 2008, Truvada and Atripla achieved sales of $479.4 million and $324.2 million, representing a growth rate of 37% and 70% over the 1st quarter of 2007, respectively.

The robust demand in Truvada and Atripla is likely to continue in the coming years. There are more than 40 million people worldwide are infected with HIV today and each year 5 million people become infected by HIV. In the US, 1.2 million people are estimated to be living with HIV/AIDS and it is expected to be 2 million in 2019. Each year, 40,000 new infections occur in the US, 70% of which are infected by HIV carriers who are not aware of their own situation. According to a study conducted by Datamonitor, in the major HIV therapeutic markets, a significant proportion of the HIV and AIDS patient population are “untapped”, therefore absent to subsequent treatment. Hartford Courant (of Connecticut) recently reports that “the numbers (of HIV infections) are skyrocketing among blacks and Latinos” and they are “not on the radar screen”. Dr. Beny Primm, the executive director of Brooklyn’s Addiction Research and Treatment Corp, served on President George H. W. Bush’s commission on HIV. He alerted in Hartford Courant that “in some US cities, the numbers of HIV/AIDS cases are reaching those found in the developing world. In Washington D.C., one in every 16 people ages 18-44 is HIV-infected. In New York city, one in seven black men ages 34-55 in Harlem is infected, as is one in 14 in Manhattan”. Germany also reports an increase in HIV infections, mainly in large cities (source: Deutsche Presse-Agentur), let alone the AIDS epidemic in African countries.

There are about half a million HIV patients worldwide are currently treated with one of Gilead’s four antiretroviral therapies. As the voices of concern are raised in the society and more patients become aware of their infected situation, more patients would come to receive treatment and improve their health. As a dominant supplier of effective treatment for HIV/AIDS, Gilead poises to continue to derive more earnings growth with its flagship HIV products. Currently the street consensus expects that Gilead will achieve earnings growth 11.9% and 14.3% for current quarter and the next quarter, respectively. Gilead has managed to beat the earnings estimates for the last several quarters, and it is reasonable to expect the trend of positive surprise could only continue given the strong demand of its products, the benefits that its drugs bring to the patients, and its competitive position in the market place.

Industry Landscape and Gilead’s Competitive Position

The HIV market is expected to grow at a compounded annual growth rate of 10.3% during the period 2006-2012, mainly driven by gains associated with the launch of new classes of HIV drugs, such as integrase inhibitors.

With over 50% of market share and captured $4,671 million in sales in 2006, Nucleoside Analog Reverse Transcriptase Inhibitors (NRTIs) are currently the leading drugs for HIV patients. The major driver behind the growth of NRTIs has been the increasingly popular fixed-dose NRTI combinations, led by Gilead’s Truvada. Other major players in HIV market include GSK, Bristol Meyers, Abbott, Roche, Boehringer Ingelheim, Pfizer, Merck, Barr and Kohl Medical.

Yet the advent of Gilead’s Truvada and later the debut of Atripla have changed the competitive landscape of the global HIV drug market. These innovative products are the most potent yet least toxic HIV products available. They not only are proved to be safer and more effective compared to those of their competitors, but also provide tremendous convenience to HIV patients, significantly improving the compliance of patients by simplifying the drug in-taking process. HIV patients usually have to take a combination of at least three drugs for the treatment since HIV can quickly mutate into drug-resistant strains. And more often HIV patients take medications for other illness such as heart disease, high blood pressure, diabetes or asthma, etc. Experimental studies show that, once taking more than six pills a day, patients’ compliance falls off. If a patient takes fewer than 95% of the prescribed drugs, the virus can render a medication ineffective and a change in treatment is required. The quality and convenience of Gilead’s HIV products have helped Gilead to take market shares from its competitors in the recent years. The single, once-a-day dose of HIV drugs from Gilead have been embraced overwhelmingly by many AIDS patients and the trend can only be expected to grow. In 2007 Atripla was added to the Model List of Essential Medicines by the World Health Organization, and received marketing approval in Canada, the European Union, Norway and Iceland.

Many HIV patients develop resistance to current therapy after being on a therapy for a certain period of time, and there is an urgent need for novel products that are active against drug-resistant HIV. To patients who have developed HIV resistance to HIV drugs that target two major enzymes: reverse transcriptase and protease, Gilead soon might have the therapeutic solution – an integrase inhibitor, elvitegravir, is currently in advanced clinical trials. According to many experts, integrase inhibitors are one of the most promising HIV drug classes in the new product pipeline, and have the potential to be used across a broad segment of the HIV population. Gilead’s most advanced pipeline candidate for HIV, elvitegravir, targets a different stage in the HIV replication in patients currently resistant to other treatments. It blocks the integrase enzyme to prevent HIV from replicating itself. Gilead announced the successful completion of a Phase II clinical trial of elvitegravir in 2007. It has received the FDA’s consent and currently is in the late stage of completion of the design of the Phase III clinical trial for levitegravir. The phase III clinical trials are planned to be initiated in 2008.

In the hepatitis B market, the extended indication of Viread for treatment of Hepatitis B could enhance Gilead’s competitive position and improve profit margin. The efficacy of the indication of Viread for hepatitis B was discovered in the data generated from its HIV trials for Viread. With relatively small incremental new R&D or human capital investment (versus a regular investment of 200 million to 500 million to develop a new drug), Gilead could bring a drug with the potential to suppress HBV in patients co-infected with HIV and HBV. The investment-reward profile seems to be quite favorable.

The hepatitis B could be another growth engine for Gilead. It is estimated that of the 400 million people who are chronically infected with the Hepatitis B virus worldwide, only a small faction of the infected population are receiving treatment. The mortality rate resulting from the complications of the disease is about 25%. Although there are already several big pharmaceutical companies with strong presence in the hepatitis B market, there is sufficient critical mass in the market for new entrants, especially for those companies with innovative products that could be tailored to suit the needs of hepatitis patients. As a matter of fact, many pharmaceutical companies invest significant amount of R&D capital and human capital in the development of molecules for treatment with more efficacy. The huge unmet needs not only attract and encourage many new entrants into the market, but also present a great opportunity for established players in this market. In 2007, Gilead’s once-daily Hepsera remained the most-prescribed oral antivira treatment for patients with chronic hepatitis B in the US., accounting almost close half of all oral antiviral prescriptions. With the strong presence of Hepsera and the extended indication of Viread, which is expected to be available in the market in the second half of 2008, Gilead is well positioned to benefit from the hepatitis market opportunity.

Fundamental Valuation

Gilead is currently traded at about 30x of P/E, and its earnings growth is expected to be 22.72% for the next five years; and that gives us a PEG ratio of 1.34. It is estimated that Gilead will achieve sales growth of 17.9% and 21.1% for current and next quarter, respectively, and earnings growth of 17.26% and 15.23% for current and next year, respectively. The resultant earnings per share estimates are $1.97 and $2.27 for current and next year, respectively. Assuming that the premium given by the market to Gilead remains the same, which is about 30x, and using the earnings consensus from Wall Street firms, the target price would be $59.1 and $68.1 for the current and next year, respectively.

Yet the Wall Street consensus might underestimate the growth potential for Gilead’s major products. In 2007 Atripla was the most-prescribed regimen for patients new to HIV therapy in the US. Gilead has been actively engaging in advocating “self-awareness of HIV” campaign and providing free tests for high risk population for AIDS. As more patients become aware of their HIV-affected situation, most of them will resort to treatment and seek the best medicine available. We believe that Gilead’s HIV products’ superior quality and convenience will continue to enable the company to expand its market share, therefore outperforming analysts’ current estimates for the coming quarters, just like what Gilead has done for the last several quarters.

Major Risk Factors

Failure to meet the end-points in its clinical trials for its major pipeline product candidates imposes the greatest risks of impeding earnings growth on Gilead’s future performance. On May 20th, US Patent & Trademark Office confirmed the patentability of Gilead’s the first of four Viread patents; and negative rules on the remaining three Viread patents represent other major risks for Gilead.

Recommendation

Gilead is one of the greatest biotech companies in the world that provide critical solutions to meet the unmet needs of many patients worldwide. Its innovative products, dominant market position and great product pipeline present promising investment opportunity for investors.

Gilead has been in steady growth mode for several years. Over the last 5 years, Gilead has achieved 55.4% growth for revenue and 80.58% growth for EPS. Its highly profitable business operation, with operating margin of 51.17% and net profit margin of 38.19%, provides great level of margin of safety from the business perspective. The highly experienced and effective management team has delivered great returns for many years. With a total debt-to-equity ratio of 37.58%, Gilead is able to realize 61.14% of return on equity and 39.7% of return on invested capital. To achieve great returns with relatively small leverage, the management team at Gilead has demonstrated its ability to drive the company to achieve great profitability.

Based on Gilead’s daily price and volume data over the last three months, we see that Gilead’s stock has been experiencing moderate accumulation and is in the process of forming a support base. With much economic uncertainty and market volatility in the market, Gilead presents a wonderful growth investment opportunity along with a defensive posture.

Disclosure: Long

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