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Gilead Sciences (NASDAQ:GILD) has posted better than expected third quarter results on the back of strong sales of Truvada, and exceptional growth of Complera. There is upside potential for the stock, on the premise of strong growth for its newly-launched drug Stribild, and the progress with the Hepatitis C drug. Since our last buy recommendation, the stock is up 16%. We remain bullish on the stock, and recommend a buy position.

Gilead Sciences, whose primary areas of focus include the human immunodeficiency virus (HIV), liver disease (Hepatitis B and C) and cardiovascular/metabolic and respiratory conditions, is a biopharmaceutical company that aims to discover, develop and commercialize medicines. Its major products include Truvada, Atripla, Viread, Complera, Emtriva, Hepsera, Letairis, Ranexa, Lexiscan/Rapiscan etc.

The company's top performing drugs remain Atripla and Truvada; both antiviral drugs and targeting HIV/AIDS. Their patent expirations are quite ahead in the future i.e. in 2021. In results for the third quarter (ended September), we notice revenue figures of $2.43 billion, up from $2.12 billion for the same period last year, representing an increase of 14%. Earnings adjusted for one time items stood at $1 per share, beating analyst mean estimates of $0.94. Earnings per diluted share stood at $0.85, falling from a high of $0.95 last year.

Contributors to the growth in sales for the quarter were the anti-viral segment, with drugs such as Atripla, Truvada, Viread, Complera and Stribild. In the table below, we break down the drugs' respective performance.

Table 1:

Product Name

Revenue Increase

Complera

5x

Viread

11%

Atripla

9%

Truvada

8%

Truvada is an oral formulation, once daily, part of a combined therapy to treat HIV infection in adults. It is a fixed dose combination of Viread and Emtriva. Sales for the drug stood at $804 million. Truvada has been used for the treatment of HIV since 2004, and was recently granted approval for as an AIDS prevention drug. Previously in our article, we highlighted the potential of a sales increase for this drug due to the aforementioned approval. After the approval, the drug can be used by those who are exposed to a high risk of infection, and those who engage in sexual activity with HIV positive people. According to studies, the drug was shown to reduce the risk of contracting the disease by 73% at most.

Atripla is a once daily single tablet regimen for HIV, intended both as a standalone therapy and as a combination with other antiretroviral. Sales for this drug stood at $865 million. Together, both Truvada and Atripla accounted for ~69% of total sales and ~82% of anti-viral drug sales.

The recently launched Stribild, known as Quad prior to FDA approval in August, witnessed sales figures of $17.5 million. Stribild combines four other compounds: elvitegravir, cobicistat, emtricitabine and tenofovir (these last two comprise Truvada) into a single-tablet regiment ((NYSE:STR)). The drug is predicted to bring in some $3.47 billion in annual sales for the company by 2017.

According to an article on the Financial Times, the guidelines list Stribild as an alternative rather than recommended regimen among drug combinations containing integrase inhibitors. These inhibitors stop the progression of the viral enzyme known as "integrase", which plants the viral genome into the DNA of the host cell. The blocking of this process, which is a key step in the retroviral replication process, can prevent the spread of the virus.

Gilead's Atripla and Stribild could face potential competition from Dolutegravir, which is an experimental drug from GlaxoSmithKline (NYSE:GSK) and Shionogi (GSK's Japanese partner). In a late stage clinical trial, GSK's drug registered results that suggest better efficacy than GILD's Atripla.

Dolutegravir belongs to the same class of drugs as GILD's Stribild i.e. integrase inhibitors that fight the HIV virus by blocking its way into the host's cells. According to announcements made by the company, Dolutegravir could hit the market by the end of 2013, and step up competition in the HIV drugs industry.

Although traditionally, the company's main strength has been its HIV drugs, the company's future is also tied to the success of its experimental drug (GS-7977) aimed for the treatment of Hepatitis C. Also, investors should closely monitor the upcoming annual meeting of the Association for the Study of Liver Diseases in the next month.

The drug was acquired along with the acquisition of Pharmasset for $11 billion in a bid to diversify away from the HIV market and move into the growing Hepatitis C medicine market. Pharmasset was developing oral drugs for the treatment of the ailment. The deal was criticized, especially for reasons that the price tag for a company (Pharmasset) that is not expected to generate profits for two years was too high.

Gilead expected that the patient would eventually move away from the traditional treatments of Hepatitis C, which require frequent therapies, injections etc, to more convenient all-oral regimens, regardless of viral genotype. The virus, which swells the liver, affects nearly 170 million people worldwide. But Gilead is not alone in the race to capture the HCV market with the use of oral drugs.

Merck (NYSE:MRK), Roche (OTCQX:RHHBY), Johnson and Johnson (NYSE:JNJ), Abbott Laboratories (NYSE:ABT), Vertex (NASDAQ:VRTX) and Bristol-Myers Squibb (NYSE:BMY) have been making inroads into the development of the drug, one way or another. For example, BMY and ABT posted encouraging results relating to their drugs for HCV.

Valuations:

Table 1: Competitors

GILD

BMY

ABT

MRK

JNJ

Average

Forward P/E

15x

18x

12x

12x

13x

14x

Chart 1: Gross Margins

The company has one of the highest gross margins (Chart 1) in the industry and has been generating substantial cash flows (Chart 2). The stock trades at 15x its forward earnings, with the market estimating a long-term earnings growth rate of nearly 15%. Our baseline view is that Stribild will greatly contribute to the growth in revenues in the future, and with the current dominant position of Gilead in the HIV market, we expect its position to strengthen further with the launch of the product.

Chart 2: Cash from Operations TTM

Also, once the HCV drug hits the market by 2015, we expect Gilead to tap in a wide market, providing another stream of revenues for the company. The analyst mean estimate price target is $74, with the most bullish target being $89. Barclays and UBS have a price target of $73 and $80, respectively. In light of the recent developments, we rate the stock a buy.

Graphs have been sourced from YCharts

Source: Buy Gilead Sciences: HIV And Hepatitis Drugs To Drive Growth