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There Is A Portfolio Balm In Gilead

Jul. 11, 2016 7:31 AM ETGilead Sciences, Inc. (GILD)
Please Note: Blog posts are not selected, edited or screened by Seeking Alpha editors.

Summary

  • Gilead is far and away the market leader in HIV and HCV treatments.
  • It outperforms other traditional DGI drug companies.
  • I opened a position in a prediction to realize income potential.

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Brexit was supposed to signal a chain reaction of mass carnage in markets throughout the globe. There was supposed to be blood in the streets. In fact, everything that was supposed to happen is hard to keep track of, because the reporting skill of financial news is at least equaled by its penchant for hyperbole.

In this case, it was all true. For two days:

Putting the conjecture about long-term effects of Britain leaving the European Union on hold, what remains is an environment in which zero and even negative interest rates on fixed income assets are forcing countless individual and institutional investors to choose stocks in my universe (dividend growth) to quell their need for income.

This causes the traditional names that one would typically add to a growing DGI portfolio to be on sale at nosebleed prices. As a case in point, Chuck Carnevale recently noted that out of all the S&P Dividend Aristocrats (50-some stocks that have raised their dividends for 25 consecutive years or more), only seven could be considered as fairly valued.

So for someone in my position, twenty-eight years or so from retirement, with options not being an option (pun intended), I see three scenarios to deal with this situation:

  • Discount the time value of money and build a prodigious cash position to buy shares in the next market correction. The glaring problem with this is that no one knows when this inevitable market correction is coming, and there's nothing in the rules of investing to mandate that because a stock market is overvalued, a correction must be imminent.
  • Ignore the nosebleed valuations and buy the securities anyway. One could argue (and did) that I already did this once with my recent purchase of Hershey (HSY).
  • Look in nontraditional places for dividend growth.

It could easily be maintained that #3 is what someone with my time horizon should be doing, anyway. Besides, just because Genuine Parts (GPC) has raised its dividend for sixty years in a row does not automatically mean they'll make it to ninety. Instead, I've decided that a portion of my portfolio should be devoted to finding companies that I think have great potential of becoming the next Dividend Aristocrats. This strategy led me to my recent purchase of Gilead Sciences (GILD).

Past and Present

For NBA fans, November 7, 1991 was a shot heard 'round the world. Los Angeles Lakers legend Earvin "Magic" Johnson announced that he was retiring from basketball effective immediately because he had tested positive for HIV. Team doctors were concerned that the rigors of playing a full NBA schedule would put his health in peril, and Magic didn't want to "harm the game".

Much has changed in the almost twenty-five years since then. For one, Magic Johnson was back playing basketball by the next season (to the trepidation of some), would retire again, come back again and even have a triple-double in 1996. For two, HIV has been transformed from a virus that was for its victims a ticking time bomb because the only drug at that time, to channel Dan Patrick, "could not stop it; it could only hope to contain it" - to a virus that while by no means a cake walk, if it's caught early enough these days, does not prevent a normal life span.

Gilead is in front and center of this. More than 70% of new HIV patients in the US in 2015 were prescribed Gilead products, and another 7 in 10 newly-diagnosed patients in Europe were given treatment with a Truvada backbone.

Even so, this company that was founded in 1988 in Foster City, CA, has had several new HIV medications approved in 2016 - Descovy, which is essentially Viread 2.0, Odefsey and Genvoya.

HIV continues to be a major health issue in developing countries, though. Gilead is seeking to address this, however. They've received approval to make Truvada for PrEP in South Africa and Kenya (as well as Canada) and is part of the Medicines Patent Pool, an international organization that expands access to HIV medication through patent sharing.

Promise

You know her. She's your coworker who's a little bit "out there". Of course Elvis faked his own death. But Thursday she said that pharmaceutical companies have absolutely no interest in actually curing diseases because this would dry up their revenue.

Gilead by itself has done enough to prove her wrong, in that they've kicked Hepatitis C in the teeth. Not only did they already have Sovaldi for treating Hep-C genotypes 1, 2, 3 and 4 and Harvoni for treating genotypes 1, 4, 5 and 6 (when no other competitors had any nucleotides remotely close to marketable), but at the end of June the FDA approved Epclusa as the first-ever all-oral single tablet regimen to knock out all six genotypes of Hepatitis C:

"The approval of Epclusa represents an important step forward in the global effort to control and potentially eliminate HCV as it provides a safe, simple and effective cure for the majority of HCV-infected patients, regardless of genotype." - Dr. Ira Jacobson, Chairman of the Department of Medicine, Mount Sinai Beth Israel (emphasis added)

Single tablet regimens mean two great things. First, since there are less drugs to take, there is less chance for side effects in patients, making it more likely for them to take the full regimen. Second, "single tablet regimen" means less expensive outlays for patients, hospitals, insurers, etc., since money is not needed to fork over for all the medicines for what was a cocktail.

But not only have they taken a great step in knocking out Hep-C, Gilead has made great headway in HIV as well. Their GS-9620 has shown promise in SIV-infected monkeys. Also, they have started providing grants for up to three years to academic institutions, community groups and nonprofit organizations "engaged in HIV cure activities".

As with any drug company, the key to its success is what drugs are next. Patent protection does not last forever, of course. And with major patent expirations coming down the pike, the inevitability is certainly there for generics to duplicate Gilead's crown jewels.

The problem with that is this graphic:

As of right now, Gilead is essentially the Apple (APPL) of biotech - 90% of sales coming from just two branches of products. However, there are also drugs in the pipeline to address rheumatoid arthritis, COPD, Chrohn's Disease and Acute Myeloid Leukemia.

Frankly this is all I probably should share here. Fellow contributor DoctoRx recently dropped the mic on any discussion of Gilead's pipeline for the foreseeable future. You can read it here and I commend it highly.

Barring a blockbuster in the pipeline or two, Gilead could always go out and acquire one, such as they did with Pharmasset. There have been many to clamor that they do just that. Patience is a virtue.

Profitability

Of course all the promise in the world means little if Gilead doesn't have the organizational wherewithal to pull it off. For this, I want to see what they're doing with the money that is coming into the business - via their customers, their creditors and the other shareholders before I came along.

In a word, it's been fantastic. Compared with a number of traditional drug companies a dividend growth investor like me would typically go for, Gilead knocks it out of the park in getting more out of each dollar of sales:

It also does a better job of getting returns on the assets on its books and the capital invested into the business:

Given all this, it seems quite crazy that Bristol-Myers Squibb (BMY) is trading at 80x earnings, Eli Lilly (LLY) and Merck (MRK) are each trading at 36x, Pfizer (PFE) is trading at 29x, Abbvie (ABBV) is trading at 19x earnings, while Gilead is trading at under 8x earnings - lower than Fiat Chrysler (FCAU)!

If Gilead traded at the 30x earnings that was the average of the four lower ones above, it would be trading at $350. Certainly I'm not calling for that. I am only saying that Gilead is ridiculously undervalued.

Income Prospects - Really?!

Fellow SA contributor Jonathan Weber wrote a little over a year ago, that it's not whether or not Gilead can become a dividend growth company; it's whether or not it wants to. I opened a position at $82.87 because I vote yes.

There's a growing body of evidence for shareholder friendliness. First, since Valentine's Day 2014, they've reduced the number of shares outstanding by over 13%. In 2015, they returned about 3/4 of free cash flow to shareholders through dividends and those buybacks. And in April they announced their first-ever dividend increase, 9.3% to $1.88 per share.

At the current rate, the dividend represents only 16% of earnings and 14.1% of free cash flow. There's plenty of room for it to grow. In fact, with the amount of cash Gilead generates, its free cash flow yield is over 15%.

Summary

Admittedly, one dividend increase is very thin evidence. As a result, I'm giving it a short leash in that regard. However, from my purchase price it is in my personal opinion about 40-45% undervalued. So there is realization for upside even if that fledgling dividend growth were to stagnate. It's priced as though the company cannot get out of its own way, but there is plenty of upside here for both the growth and income investor.

Disclosure: I am not a professional investor, and as such, the companies and/or positions mentioned and any associated analyses are related to my own personal experience and expertise, and is not intended to be a recommendation to buy or sell. As everyone has their own risk tolerance, goals and needs, it is important that you perform your own due diligence.

Analyst's 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.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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