Gilead Sciences Q1 Key Insights

| About: Gilead Sciences, (GILD)

Summary

Gilead’s stock price dropped despite an already low P/E ratio.

Stock buy-back program will generate even better returns at the lower price per share.

The insurance bureaucracy is loosening up on Harvoni prescriptions.

There could be more HCV patients to treat than previously thought.

After Gilead Sciences (NASDAQ:GILD) reported its Q1 results on April 28 the market reaction was extremely negative. I believe this reaction was irrational because the value of Gilead's future earnings was already discounted in the stock price, as reflected in its low price-to-earnings ratio (P/E).

In only one scenario is the low Gilead price justified: if Harvoni sales for HCV (Hepatitis C) continue to decline, and decline substantially. I don't know if Harvoni sales will improve in Q2, but there is reason to believe they will at least flatten out.

Revenue Drop, Price Drop, and P/E

Here's how Gilead Q1 drug revenue compares sequentially and to sales in Q1 2015, by individual therapy:

Gilead Revenues by product ($ millions):

Q1
2016

Q4 2015

Q1 2015

y/y increase

Atripla

675

800

$734

-8%

Truvada

898

936

771

16%

Viread

272

306

234

16%

Stribild

477

511

356

34%

Genvoya

158

45

0

na

Complera

381

380

320

19%

AmBisome

86

74

85

1%

Ranexa

144

169

117

23%

Letairis

175

192

151

16%

Sovaldi

1,277

1,547

972

31%

Harvoni

3,107

3,345

3,579

-13%

Zydelig

49

40

26

88%

Other

44

49

60

-27%

Note that a majority of drugs saw y/y increases in sales. But Harvoni accounts for such a large proportion of sales, its y/y decrease almost wiped out all the increased sales from other drugs.

Total Gilead revenue was $7.79 billion, down 8% sequentially from $8.51 billion and up 3% from $7.59 billion in the year-earlier quarter. Sequential decreases in drugs sales from Q4 to Q1 are not surprising because of annual resets of deductibles. But 8% is more than usual, and in the past Gilead revenues were ramping so quickly this seasonal effect appeared more as slow growth than as an actual decline.

Some analysts and some financial writers have been anticipating a slowdown in Gilead's growth rate for well over a year. In theory that is the reason (if markets were rational) for Gilead's low P/E ratio. In theory if a company that has its stock price discounted because of an anticipated future event, and the event occurs as expected, there should be no change in the stock price.

But theories (and rational economists) do not buy and sell stocks much. Usually both short-term traders and trading algorithms react negatively to negative news, even if in theory it has already been incorporated into the stock price. So GILD fell $8.79 or 9% per share on Friday to close at $88.21. That was getting near the 52-week low of $81.99. Some analyst downgrades hurt too. You can pretty much tell which analysts are idiots when they downgrade after an "event" like this.

Buy Back Program

As a long-term investor I start my analysis of buy-back programs from a neutral perspective. I have seen companies with high P/Es buy back their stocks, and to me that is just a stupid investment. It only helps short-termers. But Gilead has a P/E ratio of 7.5, which means buying back stock creates a return of 13.3% on the cash used. Where else can you get a 13% return?

Gilead bought back $8 billion of its stock in Q1. An additional $12 billion repurchase plan was authorized.

I'd rather Gilead buy back its shares at $88.21 per share than at $97.00. We can buy more shares that way, with greater benefits to current shareholders. Bummer if you were going to sell shares to buy a Porsche on Friday, or whatever, but for long-termers this dip is not a problem. And if you want to get in and enjoy the returns and dividend and likely price appreciation, it is good for you too.

I already own more GILD than my portfolio limits would normally allow. As far as I can tell it is the best bargain in the entire market. I am happy to have Gilead decrease the number of outstanding shares, which increases (the admittedly tiny) percent of the company my shares represent.

Harvoni Reimbursement Environment

Harvoni pill source: gilead.com

Since Harvoni revenue were down, it is important to consider the factors that might make sales continue to decline, or to level out, or to rise again.

Harvoni was approved by the FDA in October 10, 2014 and by the EMA (Europe) on November 18, 2014. Here are the sales figures since the launch:

Quarter

Harvoni global revenue, $ millions

Q4 2014

2,107

Q1 2015

3,579

Q2 2015

3,608

Q3 2015

3,332

Q4 2015

3,345

Q1 2016

3,107

Note that in its first commercial quarter Harvoni generated an unprecedented $2.1 billion in revenue. This was because patients were lined up, ready to take it. Harvoni is highly effective (for the genotypes on its label) and delivered as a single pill. Prior to Harvoni less effective regimens required shots plus a large number of pills. Even the prior most effective therapy, Sofosbuvir + peginterferon + ribavirin required up to seven pills per day and one shot per week, and had more side effects.

Harvoni's introductory pricing was notoriously high, about $1,000 per pill, or $80,000 for a typical course of the drug. So insurers reneged on their contracts with patients to pay to treat illnesses as they arose, though in fairness to insurers it should be noted that they had not raised premiums in advance to be able to budget for an event this size. The climb to peak revenue in Q2 2015 was done despite only the most seriously ill patients getting approvals from insurers for reimbursements.

During 2015 prices (real paid prices, as opposed to list prices) were negotiated down and the first large bolus of patients finished receiving therapy (with very high cure rates). On January 1, 2016 many of the contracts reset, with Gilead granting lower prices to insurers that approved more prescriptions. In effect the less ill began to see insurers approving their doctors' scripts.

Most reasoning for a low price for Gilead stock assumed that competitor entries in the HCV market would both drive down prices and take market share from Gilead. But despite the competition Gilead estimated that for Q1 2016 it had 90% of the HCV market (including Sovaldi as a single agent; it is a component of Harvoni).

It is quite possible that, given the new pricing and policy of treating less ill patients, we will see Harvoni revenue trend flat to upward for the rest of this year.

What this means is that it is likely that Q1 was an off quarter, rather than a typical quarter or the beginning of a soft or hard decline. Certainly Gilead management believes that. Gilead stood by its prior guidance of product revenues between $30 and $31 billion. At the low end that works out to $7.5 billion per quarter. Product revenue in Q1 was $7.68 billion. Revenue in Q1 2015 was $7.41 billion. At the high end the guidance is for $7.75 billion average per quarter. Meaning small increases in future quarters of 2016.

That still leaves the question of where significant post-Harvoni growth will come from. If that were visible the P/E would likely rise. Revenue growth would depend on the therapy pipeline, which I will not be addressing in this article, but other Seeking Alpha articles have gone over it in considerable detail.

How Many HCV Patients Are There?

People are not routinely screened for HCV in the U.S. or around the globe. Generally, only people with symptoms or in high-risk groups are screened. As a result, estimates of infection rates vary widely. So the size of the pool of potential Harvoni patients (or for Gilead and competitors' future HCV therapies) is somewhat uncertain. WHO estimated the global number for HCV infected persons as between 130 and 150 million.

Gilead has been sponsoring test programs for increased screenings for HCV. One place they are screening is in select U.S. urban surgical centers. There the rate has turned out to be surprisingly high, around 10%. That might be a special case, but if it holds up for the general population, it would imply there are over 30 million people in the U.S. alone who would require treatment. If true, either the high risk groups are more prevalent than previously thought, or somehow the virus had spread to lower-risk groups.

For those who need to make investments for the really long run, like pensions and family trusts, this is important news. Harvoni is s cure, and hence could run out of patients if there are not so many patients. Even if the cure rate ramped up to a million per year it would take 30 years just to get the currently infected treated. The patent would expire long before that. Again, this is assuming the 10% rate holds up. Probably we won't know the true rate until screening is the rule rather than the exception. Screening and curing before the liver is damaged would be a very reasonable public health goal.

Dividend and summary

Cash flow in Q1 2016 was $3.9 billion. Cash balances and debt were roughly balanced at near $22 billion each. Gilead is in a good position to make acquisitions or companies or of specific therapies.

As announced back in Q4, the dividend for Q1 was increased to $0.47 per share, to be paid on June 29, 2016 to shareholders of record as of June 16, 2016. Normally I prefer companies to return some profits to me in the form of dividends. However, as discussed above, I think it makes sense for Gilead to opportunistically buy back its stock, at least while its P/E is below about 20.

2016 looks like it will be a relatively slow growth year for Gilead, but that should not stop anyone from investing. In terms of cash generated or earnings per dollar invested in shares, Gilead is a great buy. The profits from Harvoni and other therapies will be invested wisely. Gilead is the leader in antiviral therapies. Over time it will likely become a stronger competitor in other liver diseases like NASH and in cancer therapy. I believe Gilead will provide high returns to investors for decades to come.

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.

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