Gilead Sciences: Stable But Non-Inspiring

About: Gilead Sciences, Inc. (GILD)
by: The Value Investor

Gilead Sciences has seen the arrival of sales stabilisation.

This is driven by the fact that HCV declines carry less weight and a strong HIV performance, as the performance of the remainder of the business remains lacklustre.

Real gaps in the pipeline fail to bring imagination to the shares.

At 12 times realistic earnings while operating with a flattish net cash position, Gilead remains a real value play with stable sales for now.

Gilead Sciences (GILD) has been a name which I have owned at various instances in the past, and still hold a modest position in the shares. I have typically been very appealed to the strong balance sheet and modest valuation of the business, following its unprecedented success and subsequent decline of the HCV business.

The success and erosion of the HCV business made Gilead the "victim" of its own success, as I recognise that sales stabilisation going forward and strong balance sheet make Gilead a core holding.

About The Numbers

Gilead reported fourth-quarter sales of $5.79 billion, a "mere" 2.6% decline on annual basis, while full-year sales were still down more than 15% to $21.7 billion for the year of 2018. This number makes that sales stabilisation within reach.

The shortfall in sales continues to be driven by the HCV franchise, including products like Sovaldi, Vosevi, Harvoni and Epclusa. Revenues from these drugs came in at $738 million in the fourth quarter, down from $902 million in Q3 of 2018 and down from $1.5 billion in the last quarter of 2017. Full-year sales came in at just $3.7 billion in 2018, down from $9.1 billion in 2017, as sales are now running at a run rate just below the $3-billion mark. Continued sales declines continue to have less of an impact, with HCV now making up less than 13% of combined sales reported for the fourth quarter.

Gilead furthermore benefited from a strong quarter at the HIV franchise. Included in this franchise is Biktarvy, Descovy, Genvoya and Odefsey, combined generating $4.1 billion in sales in 2018, a solid uptake from $3.4 billion reported in the final quarter of 2017. For the year, sales of this franchise rose by little over 10% to $14.6 billion.

This leaves two smaller segments. "Other drugs" include 6 established products: AmBisome, Zydelig, Ranexa, Letairis, Viread and Vemlidy. Sales from these products are actually trending a bit lower as of recent, despite having reported growth in recent years. Combined revenues came in at $797 million for the quarter, down 10% from the same quarter a year before, as sales for the year fell to $3.1 billion.

Other than HIV there was only one bright spot and that has been Yescarta, which the company obtained when it bought Kite Pharma little over a year ago in a $12-billion deal. Fourth-quarter sales came in at $81 million, compared to $7 million in the same quarter a year ago. Problematic is that sequential sales growth is non-inspiring with third-quarter sales amounting to $75 million and second-quarter sales coming at $68 million, which makes that this is not a bright spot after all. The current run rate of $325 million is too low to justify that deal tag.

About Earnings

The earnings picture for the fourth quarter was quite complicated as GAAP earnings amounted to just $3 million. Adjusted earnings for the quarter came in at $1.87 billion, a 20% fall compared to the year before. One key reason for that has been a big charge on the deal with Kite at a +$1 billion actual expense as Gilead formally recognises that Yescarta is not living up to its promises.

The company furthermore had to deal with a large tax charge as well as a $0.10 per share charge in relation to stock-based compensation expenses. If we assume that the $1.44 non-GAAP earnings per share number is fair but do adjust for stock-based compensation, I see realistic adjusted earnings at $1.34 per share. For the year the company reported adjusted earnings of $6.67 per share, which after excluding for $0.52 per share in stock-based compensation expense, works down to $6.15 per share in a more realistic earnings power estimate.

The Outlook

For the current year, sales are seen at $21.3-21.8 billion, more or less suggesting flattish sales compared to 2018 as stabilisation might have certainly arrived. Based on the midpoint guidance of gross margins of 86%, $3.7 billion in R&D, $4.0 billion in SG&A and a 20.5% tax rate, I see earnings at $8.6 billion, or $7.6 billion after including a billion in net interest expenses. With 1.28 billion shares outstanding that works down to adjusted earnings power of $5.94 per share, suggesting further earnings declines in the coming year, but in line with the current run rate based on fourth-quarter earnings.

This confirms that earnings are seen flattish amidst stable revenues as well. The company continues to operate with a strong and liquid balance sheet including $31.5 billion in cash and equivalents, offset by a similar debt load, for a flat net debt load. Despite the flattish net cash position, the absolute debt holdings are large as the interest rate spread is substantial, depressing net earnings to the tune of a billion a year. If these can be forfeited as absolute cash and debt levels disappear, Gilead has room to boost earnings by a billion, or close to eighty cents per share.

Final Thoughts

I must say that I am surprised by the strength of HIV, but other than that there are few bright spots at Gilead as pipeline conversion and the Kite deal have been a real disappointment. The good thing is that stabilisation has arrived as can be seen in the outlook, as trading with a flattish net cash position and realistic earnings trending at $5.50 per share (outlook minus stock-based compensation) make that shares trade around 12 times realistic earnings at $68 per share. The reason for the low multiple is simply the lack of triggers, as Gilead has some real things to prove from here. After all, management totally mismanaged the HCV boom-bust, including the capital allocation decisions being made, although management has been replaced to a large extent already.

Having traded in and out of the stock as it has swung between the $60 and $80 mark, I am happy to gradually buy into weakness towards $65 again on top of my smaller residual long position. Key staff turnover and pipeline conversion are real risks, but the strong balance sheet, earnings power and non-demanding valuation should be comforting enough given the strength in HCV, although there are few short-term triggers on the horizon.

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.