As you likely know, Gilead Sciences (NASDAQ:GILD) reported final results from an amazing year on Tuesday after the market closed. Since everyone already knew it would be amazing a year ago, the stock is acting as though there is little if any growth ahead despite the company's stellar track record.
For those who are unfamiliar, GILD's founding focus led it to make multiple advances in the treatment of several different viral diseases. These culminated in it dominating, from a standing start, treatment of HIV/AIDS and hepatitis C. Both fields involved either partnering and/or acquisition.
The maturity of these massive commercial successes have forced the company to look elsewhere for future growth. It is the uncertainty of that situation that has led to the Street remaining unmoved. It is saying "show me" to GILD, returning the stock to $84 (and below), which is a level it first achieved 24 months ago before the repeated beat-and-raise quarters and years began evidencing themselves.
With diluted GAAP EPS of $11.91 for the full year, the stock is trading right at a 7X TTM P/E. In contrast, the S&P 500 (NYSEARCA:SPY) is trading at a 21X TTM P/E. This puts GILD solidly in the category of a busted growth stock. The transition from a growth stock to a value stock is fraught with challenges both for the bulls and the bears.
Now that I have had a chance to listen to the conference call and digest much of the earnings slides, I wanted to provide some thoughts on the stock going forward. Then, I'll sum up.
The company has chosen share repurchases and early retirement of dilution via retiring warrants as its primary means of rewarding shareholders. Dividends are secondary, as opposed to large-cap biotech peers Amgen (NASDAQ:AMGN) and AbbVie (NYSE:ABBV), which are more focused on dividend payouts than on shrinking the float.
In any case, while expanding the R&D effort (with only variable success, though), and returning very large sums to stock and warrant owners, the company also strengthened its balance sheet. This is a nice accomplishment that not enough pundits focus on in my opinion. This is the company's presentation of its year-end numbers:
GILEAD SCIENCES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
December 31, December 31, 2015 2014 (1) Cash, cash equivalents and marketable securities $ 26,208 $ 11,726 Accounts receivable, net 5,854 4,635 Inventories 1,955 1,386 Property, plant and equipment, net 2,276 1,674 Intangible assets, net 10,247 11,073 Goodwill 1,172 1,172 Other assets 4,127 2,998 Total assets $ 51,839 $ 34,664 Current liabilities $ 9,891 $ 5,761 Long-term liabilities 22,833 13,069 Equity component of redeemable convertible notes 2 15 Stockholders' equity(2) 19,113 15,819 Total liabilities and stockholders' equity $ 51,839 $ 34,664
(1) Derived from the audited consolidated financial statements as of December 31, 2014.
(2) As of December 31, 2015, there were 1,422 shares of common stock issued and outstanding.
This is strong as I see it, given copious cash flow, almost all of which is free cash flow. Even after subtraction of intangibles and goodwill from stockholders' equity, tangible net worth is around $8 B, up from about $4 B at the end of 2014.
With vast free cash flow anticipated this year (and well beyond), the company is well-positioned to make one or more acquisitions, in-licensing deals and the like, as well as to continue its buyback program. You probably noticed a separate press release that shows the company is committed to an aggressive share repurchase program this year while increasing the dividend almost 10%.
That press release can be used along with the above share count of 1.42 B shares outstanding at year-end to now make some estimates of EPS for this year.
Another EPS record appears likely for 2015 - guesstimating the number
Not that I'm a fan of forward guidance by any operating company, but we have to make the effort once a company proffers it and use its numbers.
GILD suggests we use $30.5 for revenues for this year. However, this company is notoriously stingy on its guidance. Last year, it ended up blowing away the guidance it provided after reporting Q4. So I will assume a little over $32 B and hope that's too low.
GILD then lets us assume that 10% of revenues go to production costs, leaving $29 B of gross profit. From that, we are guided to subtract about $7 B going to R&D and SG&A, leaving $22 B. From that, I subtract 20% for taxes, leaving $17.6 B in after-tax non-GAAP profits.
The next question is how many shares to use. Not that GAAP uses year-end share count, but that's what reality is should the company liquidate or get acquired, so I'll use 1.42 B as the year-end share count. What I'm not certain of is whether that is primary or fully diluted shares.
In any case, we have an aggressive share buyback. This could easily be $10 B and possibly a good deal more. Assuming a stagnant stock price, the current 1.42 B share count can shrink to 1.3 B.
Dividing $17.6 B by 1.3 B gives $13.54 per share for EPS. Subtracting the suggested $1.14 per share gives $12.40 per share, a modest increase over this year. Again, I'm not certain about whether this projected share count is the primary or diluted count.
What if we up the sales dollars to reflect greater sales, more in line with the ratio of 2015 actual sales of $32.15 B versus the company's projection of one year ago of only $26.5 B?
Adding $2 B more in sales to project $34 B in product sales (which will be very close this year to total revenues, I expect) this year would bring EPS to something around $13.50. I'll bravely go with that, which happens to match a projection I made in Q4 last year in one of my GILD articles. Remember this is GAAP, not the non-GAAP estimates and reported numbers that are widely used, including by the company.
Comments on Q4, full year 2015 and strengths and weaknesses for 2016
Of course, there's too much in the many slides the company provided, the press release, prepared remarks and Q&A to review all the material factors. I'll try to hit some high points.
1. Japan - massive Q4 sales; price cuts coming
Per Slide #23, Japan had booming sales of HCV products of $1.4 B in Q4 alone. This success is going to lead to a price cut; GILD does not know how severe it will be. Clearly, this is a large market, but given an uncertain amount of warehousing of patients and then an unknown pricing structure apparently being announced soon, it's probably correct that even GILD has a tough time forecasting sales there.
GILD has achieved something in Japan that few younger companies do, which is have its own sales force there. This may be an unrecognized asset, as it should be able to market not just GILD's own products but those of other companies.
2. US sales were weak in Q4; was it all from the VA?
GILD points to erratic funding of the VA to account for a sharp drop-off in US HCV product sales in Q4. It says that more than adequate VA funding is in place, and it expects steady US sales all year. When challenged on this in the Q&A, GILD defended its math, so I'm not going to argue. I think the company deserves the benefit of the doubt here.
The harm to sales, if any, from Merck's (NYSE:MRK) approval late last month of Zepatier for HCV, was raised in the Q&A. GILD brushed off the threat, pointing out the limitations and extra costs involved in using this drug. The company also reminded the analysts of how tough AbbVie was talking last year about its Viekira Pak competition to GILD, and how the Viekira label had to be weakened. Note that ABBV CEO admitted that this label problem cost ABBV sales beyond the small number of patients who were actually covered by the new, more restrictive label in certain types of hep C-positive cirrhotic patients.
GILD is taking a bit of a victory lap here and is going to use the extensive safe and extremely high real world cure rates with Harvoni to set itself apart from ABBV and MRK.
3. The EU is coming through
GILD is seeing rising HCV product sales in the EU. Happily, and refreshingly, it did not go out of its way to remind analysts that the euro weakened yoy against the USD. Not only is the EU growing in this market segment, but further growth is expected this year as additional smaller countries such as the Netherlands come on board and as the UK sales begin in earnest.
So with the EU growing, Japan very likely growing despite some price cuts yoy given last year had just a half year or less of sales, other international expansion coming, all the US has to do is hold even in sales for sales to grow yoy (assuming forex does not present many new headwinds).
4. Are hep C sales sustainable?
Eventually, new cases will begin shrinking in the developed countries, perhaps towards very low levels. For the US, GILD asserts that about 1.5 million cases are diagnosed but untreated, down from 1.6 million when Sovaldi came to market in December 2013. Given the many patients who have now been treated, this implies a good pace of diagnosis.
In addition, GILD estimates another 1.5 million undiagnosed hep C cases in the US. On the conference call, they reiterated their points that the prevalence of this disease may be higher than that. I think we will know a lot more in 12-18 months about the real prevalence of HCV in the US as well as the commitment of society to move towards eradication. That will give us a handle on the present value of Harvoni, the upcoming SOF/VEL combo, and the rest of the HCV franchise.
5. HIV - the empire strikes back (with TAF)
As slide 33 slows, GILD's HIV franchise has been losing ground to Triumeq and perhaps other products in the US, at least in treatment-naive patients. It is planning to turn the tide with a series of TAF-based products. Genvoya is the first of them; it is Stribild in which tenofovir in the "TDF" form is replaced by a much lower dose of tenofovir in the "TAF" form. The attraction is fewer side effects. The company professes satisfaction with $44 million in Q4 sales of Genvoya. Most of these sales came from switches from Stribild; some came from switches from other regimens, and some were of treatment-naive patients.
Overall, HIV sales were up 4% yoy. There were price increases in the US and adverse forex developments in the EU, and unfortunately, new HIV positive cases are reaccelerating in the EU and perhaps in the US as well.
I continue to believe that so long as there is no cure for HIV (GILD is working on one), GILD has a great opportunity to generate profits by regaining market share in a growth sector (sad but true) via a series of increasingly innovative TAF-based products.
As an aside, TAF is also going to be introduced in place of TDF (Viread) for the control of hepatitis B.
6. Can the pipeline help the stock get a higher P/E?
The stock of GILD and most other companies has seen P/E shrinkage in line with rising discount rates on all corporate debt except the highest-grade debt, perhaps AA-rated and above. When investors are willing to accept credit risk on a junk bond in return for a maximum annual return of 4-5% for 10 years, they can capitalize the future earnings stream of a company more aggressively than when the same bond now yields 8%. Given all the uncertainties of GILD's HCV revenue stream and its market share loss in HIV, investors have every reason to be cautious in the face of this revaluation of other forms of generating income.
Last year, the pipeline fully met my expectations in the most important fields, namely in HCV and HIV. However, there was little progress made in the rest of the pipeline, and there are some clinical trial failures in Phase 2 that were quietly abandoned. This year, the news flow is also going to be light in this aspect of the pipeline. This is reviewed on Slides 9-11.
One interesting and positive point came in the discussion of what could make investors see light at the end of the post-antiviral product tunnel. GILD pointed to the Galapagos (NASDAQ:GLPG) drug filgotinib, a deal I reviewed favorably last month. It also pointed to good evidence it has in hand that its antibody GS-5745 has efficacy in different diseases. I believe that if this product works generally, analysts will do handsprings over the stock. GS-5745 is an antibody that blocks an extracellular enzyme, MMP-9, that has been implicated in a wide variety of disease states.
The company hopes that filgotinib can be used in combination with GS-5745 and/or one of its kinase inhibitors such as entospletinib (its SyK inhibitor) to materially improve the treatment of rheumatoid arthritis.
7. Expect deals this year
This was probably the best news the Street analysts heard the whole time. A modest EPS beat to expectations is a 'meh' for GILD, but the thought of some juicy fees from enhanced M&A activity - now there's something that might get the ratings upgrade cycle in gear.
GILD was unequivocal: the decline in junior biotech stocks (NYSEARCA:XBI) has put the company in a buying mood. Let the speculating begin... my first guess is GILD's Bay area neighbor Portola (NASDAQ:PTLA).
8. No mention of China and hep C, but...
GILD is planning to file TAF in China next year for hepatitis B, which is endemic in SE Asia.
The company alluded somewhat vaguely to international expansion, which involves Asia. Analysts asked no questions about GILD's publicly disclosed activities in China.
I continue to like the optionality of a deal for GILD's SOF/VEL HCV combo to be used in China. I do not think a large deal is "priced in."
As regular readers know, I have been cautious on the stock market for some time. The last straw for me was the failure of the Fed to at least stand pat in December, but I was busy writing warning articles or phraseology well before then. This cautious attitude continues on my part. If a formal bear market is in order, no stock is safe, no matter the P/E.
In addition, GILD can describe the risks attendant to ownership of its stock in its SEC filings, and elsewhere, better than I can. I do not provide investment advice, but I do urge anyone investing in or considering investing in GILD to understand the risks to loss of capital from investing in this security at any price; such loss of capital can be permanent and significant.
Granted that all pharma companies are expected to have failures in Phase 2, otherwise they are not being adventurous enough, GILD has played things brilliantly in my view. It made the bulk of its product and entire company acquisitions when prices were depressed, then held back all last year except for a small deal here and there, such as for Phenex for its NASH candidates (one is entering the clinic this year).
Now that market prices for many acquisition candidates are off the boil, it has the cash in hand and the massive cash flow to do one or more important deals at attractive prices. When combined with what I expect to be an up year for EPS, I consider GILD to be the single most core holding for all healthcare stock investors, and perhaps the stock with the best risk-reward of any stock in the US markets.
I am not afraid of the political rhetoric coming from candidates who want to occupy the White House next year, and look at that rhetoric as setting up a classic buying opportunity in the industry being attacked. One cannot provide healthcare and destroy the leading light within healthcare, the biotech/biopharma industry. Ain't. Gonna. Happen.
In contrast, I continue to view the biotech/biopharma industry as the next great growth industry, as Moore's law reaches its limits with the 7 nm node close to as good as it gets for the semiconductor industry (quantum computing next?). Biotech is just getting going, and as a techie of sorts long ago, I can say that while tech is great/wonderful/amazing, nothing trumps human health once the basics such as clean water and the other necessities are reliably provided.
GILD is not a sure winner; no stock is. However, it has built from scratch two world-class winning franchises even while the dinosaurs of Big Pharma held every trump card. Now that it has achieved Big Pharma size, it has avoided the disease that infects so much of that industry and not grown by acquisition just because it could. Rather, it has bided its time for the biotech market to cool, raised cash at low interest rates last year, and began its bargain-hunting by buying into GLPG after that company was jilted by ABBV.
This shareholder-friendly, value-conscious behavior of GILD is a rarity. That insiders have diversified away from the stock is little more than a mild negative; I would diversify too if I were they. More important is that GILD is set to generate massive free cash flows in difficult global economic times, and has many ways to both maintain and even grow its two major antiviral franchises as well as expand into new fields. All this within one of the great growth areas of our time.
So I remain overweighted in GILD with a very patient time frame, and buying judiciously on dips.
Disclosure: I am/we are long GILD, ABBV, AMGN, PTLA.
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.
Additional disclosure: Not investment advice. I am not an investment adviser.