Gilead: What A Difference An O'Day Can Make

Summary

• GILD reported some ugly one-time charges in Q4, but with new management, no one cares.
• Uncertainties abound - more than usual for this industry - but it's clear that the TAF story for GILD's HIV franchise is playing out well.
• There's nothing like a new CEO with a track record of success at a larger player to get Wall Street to take a fresh look at a stock.
• Thus, I would tend to put a positive spin on GILD's troubles as remediable and its strengths as durable.

Background

Gilead Sciences (NASDAQ:GILD) is about to get its third CEO in less than 9 weeks on or about March 1; he will be the fourth CEO in three years. Daniel O'Day, who had the highly prestigious job of running the pharmaceutical division of the world's largest biotech company, Roche (OTCQX:RHHBY) until the end of last year, has a lot of clay to reshape at GILD. It must be more than just wanting to stay close to Genentech that led him to accept the CEO position at GILD. I presume he thinks there is real potential for GILD to shine again. Here is why, with a well-covered dividend yield of about 3.7%, GILD may be interesting as a new-money buy for risk-takers.

HIV franchise - performance and guidance

In Q4, the numbers in the earnings press release do not tell the full story. We get more information from the conference call in this case. While HIV sales were $4.1B, the CFO explained in her prepared remarks that "the quarter also benefited from seasonal inventory purchases and a favorable payer mix" which increased sales by $250 MM. The EVP for commercial operations noted yoy declines of HIV drug sales in Europe, but explained that GILD is awaiting Biktarvy's launch in several major countries, and went to comment in her prepared remarks that "Once Biktarvy is broadly reimbursed and entrenched in the market, we believe our European HIV business will stabilize and return to growth." While GILD has had trouble predicting the sales trajectory of HCV drugs, it's been good or better for HIV.

In its PowerPoint Presentation that accompanies the press release, slide 20 shows GILD guiding for sales growth of about $1.7B for the HIV franchise in 2019 versus 2018. Last year's sales of HIV drugs were $14.6B, up strongly from $13.0B in 2017. GILD is therefore meeting my long-time expectations that the feared "patent cliff" would be obviated by the advent of TAF-containing drugs. For 2019, with Symtuza (marketed by J&J (JNJ) but comprised mostly of GILD's drugs) having just begun its sales ramp and the 2-drug combo Juluca little threat so far to GILD's dominance in HIV, I'm going to take a slight "over" and go with $16.5B in HIV sales for this year.

The critical question is what GILD's HIV franchise is worth. Before getting into the major uncertainties I see with estimating its present value, next I want to deconstruct GILD's 2019 guidance. (With the CEO changes, in the interest of time, I will assume you are familiar with the puts and takes in Q4 and full-year 2018.)

Evaluating GILD's P/E

GILD is guiding to about $21.5B in revenues this year (slides 19-20). Using midpoints of the ranges shown on slide 19, I get to about $6.65 non-GAAP EPS but $5.20 GAAP. GILD's non-GAAP calculation excludes amortization of intangibles and stock-based compensation. The first represents basic accounting for cash already spent but never listed as an expense, so it's real; the other represents salary paid out in dilution to shareholders. So I only look at GAAP for GILD. But, GILD is losing patent protection on its CV line soon: Ranexa apparently in May and Letairis maybe mid-year. While these drugs could be ignored in 2015 when GILD was looking like a $30B sales company for years to come and their sales were smaller, it was easy to completely overlook these products. Now, however, p. 14 of the earnings report shows their US sales totaled $1.7B last year, or 7.8% of total sales. So I would guess that around $800 MM of GILD's 2019 sales guidance is vanishing based on about 1/2 year of sales from those two products, which I estimate at around $0.40 EPS that, since we are forward-looking investors, is better off excluded from analytic consideration to get toward a baseline run rate for earnings. That brings me to a $4.80 EPS baseline, or about 14X based on a $67-68 stock price.

Since HCV profits are inevitably trending to very low levels in the US/EU/Japan, and the situation with GILD's HCV drugs in China is murky, I cannot give the HCV franchise much value. That leaves only Yescarta and the rest of the CAR-T franchise, the small but durable seller Ambisome and the HIV franchise as the only significant marketed products.

Is a 14X P/E attractive?

Here's why I don't know. Almost everything at GILD is in flux. Beginning with HIV.

Key HIV franchise issues

1. TAF patents

FDA's Orange Book for Vemlidy (monotherapy for HBV (and HIV if desired) with TAF) shows three major patents that protect it. USPTO #7390791 appears to be something close to a composition of matter patent; it expires in May 2022. Of the other two major ones, the more basic one I'm focusing on is USPTO #8754065. This expires in 2032. Claim 1 covers a type of TAF called the hemifumarate form, as opposed to (apparently) an earlier way GILD produced TAF (as the monofumarate form). The question I have is whether GILD will end up excluding all TAF (monofumarate) competitors because - maybe - they end up inadvertently with some hemifumarate in their product. Or at least, will GILD tie them up in court for 30 months from May 2022 by suing them for infringement. I simply do not know; I do not even know Claim 1 of the '065 patent will hold up under challenge. The importance of all this uncertainty is that emtricitabine, the other member of GILD's backbone of its TAF-based HIV franchise, loses patent protection in March 2021 based on the Orange Book listing. If TAF falls in 2022 or even 2024, almost all of GILD's HIV franchise is at risk imminently; only Biktarvy would be safe well into the 2030's. But if Genvoya goes, and I think it could by patent expiry of the integrase inhibitor in it, scheduled for October 2026, then I do not see Biktarvy selling well.

Privately, I can set up probabilities of different scenarios, but since all I know about the TAF patent situation is that it is a conundrum best left to scientists and patent lawyers, I'll move on.

One of the many areas where I would like the incoming CEO to improve matters at GILD is for the company to address this issue. The generic companies will be all over the topic; why should shareholders be left in the dark?

Moving on to a brief laundry list of other issues for GILD's HIV franchise that I expect Mr. O'Day...

2. Price controls or intensified price or other competition in the US

This could come two ways. Either governments could force price cuts, or competition could force GILD to cut prices on its HIV drugs. This competition could come from ViiV, such as with Juluca and its late-stage, NDA-filed 2-drug HIV combo. ViiV has other irons in the fire, so it could threaten GILD's franchise in other ways. Or, insurers could work harder to promote TDF-based products.

3. A cure that does not come from GILD

GILD's pipeline shows its broadly neutralizing antibody platform for a curative approach to HIV is in Phase 1. If any company knows how to cure HIV infection, I would bet on GILD. But many researchers are working on a cure, and one never knows where and when, or if, one will appear. The pricing of a cure and timing of an introduction are wild cards.

In summary, regarding this core franchise of GILD, it accounts for the vast majority of the company's operating profits, and I am very confident in those profits holding up at least through the early-to-mid 2020s. If they could continue to the 2029 time frame (when Genvoya may go generic) or into the 2030s (when the last TAF patents expire), and if the other risks fail to materialize in a big way, then the present value of GILD's HIV franchise could in my view exceed its entire market cap.

Moving on to the other challenges for new management.

China

Based on "international" sales appearing more prominently in GILD's presentations, I suspect that sales have begun to some noticeable extent in China. But shareholders deserve much more disclosure.

Daniel O'Day is very familiar with China's pharma sector, given Roche's large presence there. There could be significant upside to GILD from a growing presence in China, but for now, that's all I can say.

Kite

The write-off in Q4 was not encouraging. Did GILD overpay, perhaps badly? Will Mr. O'Day like the various Kite-related collaborations that GILD has rushed into, to take cell-based therapy to the next levels? How strong will Novartis (NVS) be as a competitor? Juno under the aegis either of Celgene (CELG) or its suitor, BMS (BMY)? Will bispecifics, antibody-drug conjugates, and perhaps therapeutic cancer vaccines limit the profit potential available from Kite? Roche did not go the CAR-T route, and Dan O'Day knows why. I am very interested in his views of Kite.

Filgotinib

Once again, GILD disappointed investors on the conference call by providing no information about how to think of a US filing for RA, where the limiting factor is the MANTA study on reproductive safety in men. The company did appear to say that filings in the rest of the world can occur before MANTA results are known. Filgotinib is being shared with the drug's initial inventor, Galapagos (GLPG); I estimate that GLPG will share about 30% of profits once filgotinib is launched globally.

Filgotinib, which is an oral drug, will compete directly with other JAK inhibitors, but it looks to be 4th to the US and EU market assuming that AbbVie's (ABBV) upadacitinib is approved timely. It will also compete indirectly with Roche's Actemra, so the incoming CEO should have a good plan on maximizing profits from this drug.

This is very much a "stay tuned" situation in terms of quantifying this late-stage pipeline drug's value to GILD.

NASH

While Dan O'Day did not have experience at Roche in this liver disease, GILD's head of R&D is a liver specialist, so I expect that whatever success GILD's pipeline will have in NASH will translate into a strong underlying story. This is one area where GILD has been pretty good on the communication front. However, it moved selonsertib to Phase 3 on the basis of skimpy Phase 2 data, so this is another area where I'm waiting on the data with no preconceived view on whether the drug works as monotherapy. Different combos are being studied in Phase 2.

At this point, I do not give the NASH program much value, but because the costs are expensed and the Phase 2 program appears well-designed, every time period that passes means that the upside is closer and the sunk costs have already been accounted for. Thus, for that basic reason, I am incrementaly more positive on GILD's NASH program than I was, say, two years ago.

Risks

All equity investing has significant risks that are difficult to define. I have tried to incorporate the major ones in the above discussion. Please see GILD's regulatory filings for a more comprehensive listing and discussion of them.

Subjectively, I look at GILD as a moderate-risk investment. There are numerous unknowns, but it is possible that the stock is undervalued based solely on its HIV franchise and R&D efforts.

Concluding comments - can GILD recapitulate its prior surges?

As a reminder, GILD has moved horizontally with a downward before its HCV success:

Data by YCharts

There are now several well-defined ways that GILD can come back into Wall Street's favor. These include faster growth of the HIV franchise with better definition of the long term strategy to protect the franchise for years to come, the Kite story, filgotinib, NASH, and possibly profitable long term growth prospects in China. While I'm not expecting it, I also think that either an actual takeover offer or a market-moving rumor of such could push the stock up, at least temporarily.

As a quintessential Bay Area band observed, it's been a long strange trip with GILD, but it's never over until it's over. The band is playing on, and under a new CEO and perhaps new senior management team alongside him, GILD has the cash flow and pipeline opportunities to take its sad song and make it better.

Based on the Fed's signaling of a much less hawkish approach going forward and the strong actual and projected 2019 growth of the HIV franchise, in concert with the near-term advent of a potentially transformative CEO, I have purchased some GILD on the latest earnings-related sell-off.

Thanks for reading and sharing any comments you wish to contribute.

Analyst’s Disclosure: I am/we are long GILD, ABBV, CELG. 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.

Not investment advice. I am not an investment adviser.