Envision a company so successful its leading drugs can potentially cure the deadly hepatitis C virus after three months of treatment. A company so innovative, that its HIV medications can help people live fulfilling and fruitful lives despite being infected with the deadly virus. This biotech blue-chip is sitting on a growing pool of $30 billion of cash and equivalents, generating over $14 billion of free cash flow and has a trailing price-earnings ratio of 7. Combine that with a healthy pipeline of drugs and Gilead Sciences (NASDAQ:GILD) is poised for a major bounce back in 2017.
In 2016, biotech stocks suffered because of price gouging allegations and bad publicity generated from a number of well known companies such as privately held Turing Pharmaceuticals, Mylan (NASDAQ:MYL), generic drug maker Endo International (NASDAQ:ENDP) and Valeant pharmaceuticals (NYSE:VRX). To make matters worse, on the campaign trail, Hillary Clinton and Donald Trump publicly lambasted biotech companies for their drug pricing practices. The basket of biotech stocks, as measured by the Nasdaq Biotech Index (NASDAQ:IBB) was down over 20% in 2016. While almost no company was left unscathed, Gilead Sciences was one of the hardest hit companies in the sector. Gilead commenced the year a little over $100 a share and closed the year around $72 a share. While the massive drawdown was lightly cushioned by a 2% dividend, it was a forgettable year for a biotech blue chip with a $100 billion plus market capitalization.
While it is nearly impossible to predict a bottom when stocks are entrenched in downtrends, most of the negatives are already priced into Gilead and end of year tax loss selling is over. Furthermore, closely followed large market capitalization stocks like Gilead are quick to bounce back once sentiment shifts. This can happen for a number of reasons, but in Gilead's case, it will likely happen when top line growth surprises to the upside, a major phase 3 drug approval materializes, or a notable acquisition occurs to reverse top and bottom line declines. One company that reminds me of Gilead, is IBM (NYSE:IBM). Similar to Gilead (GILD), IBM's top and bottom line growth started declining because it's legacy IT and consulting businesses were less accretive. From 2011 through the end of 2015, revenue decreased from over $100 billion to about $80 billion, and net income dropped from almost $16 billion to $13.18 billion. Similar to Gilead, they countered the slowdown by increasing their dividend and buying back countless shares to mitigate a steeper drop in earnings per share. While this strategy was ineffective in propping up the share price over that period, IBM bounced back strongly in 2016. In 2016, IBM delivered almost a 25% net return including dividends, while the S & P 500 (NYSEARCA:SPY) returned about 10%. While IBM engaged in a number of small acquisitions in 2016, it was the shift in sentiment and lower expectations that fueled IBM's powerful rally. If Gilead is able to hold the $70 dollar level, look for a strong and swift retracement if broader market volatility remains muted.
Another major factor influencing Gilead's steep decline was its inability to execute a blockbuster acquisition. While 4th quarter results have yet to be announced, it is projected that Gilead's revenue will decline from over $32 billion in 2015 to $31 billion in 2016. Earnings per share are also expected to decline from $11.91 a share to $10.77. While an acquisition could have stymied the drop in sales and income, CEO John Milligan was not willing to overpay for an acquisition to appease Wall Street. As a result of his patience and prudent use of capital, any company Gilead was considering purchasing, if it has not already been acquired, is likely cheaper in 2017.
While the market is already well aware of the decline in Gilead's HCV business, it continues to generate tremendous free cash flow for future acquisitions, buybacks and dividend growth. While it's Hepatitis C or HCV business is in decline, millions of patients are still untreated and its HIV business is in a growth phase. With a trio of drugs including: Genvoya, Odefsey and Discovy, Gilead is in a strong position to gain market share. In its first 12 months after launching in the United States, Gilead's disruptive Genvoya drug eclipsed Bristol-Meyers Squibbs' Atripla sales. In addition to HIV, Gilead has a growing pipeline of drugs in the oncology, liver disease and inflammation departments.
Despite my rosy outlook for biotech stocks in 2017, two key risks are present and concerning. The first risk is drug pricing risk. Many of the drugs offered by Gilead and other large biotech companies are extremely expensive and the Trump administration has threatened to address this issue. If biotech companies are forced to lower drug prices, revenue, earnings and profit margins will decline. This would most likely lead to lower stock prices for drug makers like Gilead. Another pervasive concern, is general market risk due to higher valuations and over exuberant market sentiment. While these risks may not come to fruition, investors should keep these things on their radar.
In the early innings of 2017, Gilead looks to regain its momentum after a troubling 2016 for shareholders. It's HCV drugs continue to generate billions of dollars of free cash flow, and it has a trio of powerful HIV drugs, a deep pipeline in oncology, liver disease and inflammation. Gilead's coffer is filled with $30 billion of cash and equivalents and is well positioned for acquisition if an intriguing buyout candidate emerges. While the technicals are discouraging, Gilead may be bottoming around $70 a share and is supported with share buybacks and dividend hikes. If Gilead can slow down its top and bottom line declines, shareholders will be rewarded. Cure your portfolio with Gilead.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.