Gilead Sciences (Nasdaq: GILD) has not been a good investment in the last few years. In 2017, Gilead Sciences hit its lows around $65 for the first time. Since then it was mostly trading sideways and in between it briefly dipped to $60 and briefly even rallied to $90. Most investors probably didn't loose much money, but also didn't gain much (except for the dividend payments). A year ago, I published my last article about Gilead Sciences and it is time to review our investment thesis. We will give an update on the potential drivers of growth and the pipeline, but first of all reassess if Gilead Sciences has a wide moat and competitive advantage.
Moat or No Moat?
In my my article from December 2017, I claimed that Gilead Sciences has a competitive advantage over many rivals and a wide economic moat around its business. While I am still optimistic that Gilead Sciences has a lot of potential as long-term investment, I am hesitant if Gilead Sciences should be called a wide moat company. An economic moat is a structural characteristic of a company that leads to high levels of stability for the company and to duration of higher profits as well as high resilience against competitors and new potential entrants. And the last three years showed, that Gilead Sciences doesn't have these characteristics.
When asking the question if Gilead Sciences has a wide moat, I see several problems with the business that undermine the possibility to be a wide moat company. First of all, Gilead Sciences is relying on research and development and has to replace its products constantly. Although this is a typical characteristic of all pharmaceutical companies, it is a challenge for stability and consistency in a business. But not only drug makers and pharmaceutical companies face that challenge. Apple (Nasdaq: AAPL) is a good example for a company, that has to reinvent its products every year to avoid stagnating or declining revenues. The company has to release a new iPhone every year and has to rely on its ability to improve the product every year. Of course, there are several pharmaceutical companies that have a wide moat, but it is more difficult for companies that have to reinvent their products or develop new products every few years to create a wide moat compared to companies that can sell their product forever (like Mastercard (NYSE: MA) or Visa (NYSE: V)). A company like 3M (NYSE: MMM) is also relying on R&D, but having thousands of different products reduces the risk of revenue decline when one or a few products might be challenged by other companies.
And here we have a second problem with Gilead Sciences. The company is not just relying on one or two patents, but in the past, two products were extremely important for Gilead Sciences - Harvoni and Sovaldi. As these two products were so important for Gilead Science's revenue and profitability, the company simply didn't manage to replace the two products with new product launches and revenue declined severely.
(Source: Own work)
In 2015, Harvoni and Sovaldi were responsible for almost 60% of Gilead Science's revenue and as revenue declined dramatically in the years 2016 and 2017 so did the overall revenue. The chart above shows the sales decline of both products as well as the percentage of total sales that stems from Harvoni and Sovaldi (since Q1/18 Gilead Sciences doesn't disclose the Sovaldi sales any more). When we are looking at another pharmaceutical company - Novo Nordisk (NYSE: NVO) - we can see one important difference. Novo Nordisk is also facing competition, but it manages to keep sales high even for products that have lost patent protection. NovoMix, NovoRapid and the human insulins all lost patent protection, but sales for these products are still pretty stable. Novo Nordisk's economic moat is therefore not only built on the patents itself, but also on its proven ability to introduce new products constantly and having products with a high demand even without patents.
(Source: Own work)
And when comparing Gilead Sciences to Novo Nordisk we see a third problem that makes it difficult for Gilead Sciences to create a wide moat around its business. Novo Nordisk is generating most of its revenue from insulin and other products that are important for diabetics. Gilead Sciences is curing patients and with additional competition, prices decreased very fast, while Novo Nordisk can not only count on stable demand, but the number of diabetics will also increase and right now it seems unlikely that the disease will be cured in the near future.
|Gilead Sciences||Novo Nordisk|
|Experience||So far "only" 30 years of experience||Long history (almost 100 years) of successful innovation and R&D|
|Portfolio||Two product were responsible for almost 60% of revenue||Two product are responsible for about 30% of revenue|
|Demand||Curing patients (which is great for patients, but not necessary for investors)||Long-lasting demand as disease can't be cured so far|
|Resilience||Revenue from successful products (Harvoni and Sovaldi) declined dramatically||Many products (NovoMix, NovoRapid) are still generating similar revenue without patent protection|
This leaves us with three challenges Gilead Sciences is facing on its path to become a wide moat company (similar to Novo Nordisk):
- Gilead Sciences will always have to rely on research and development and will constantly have to launch new products, but it has to be able to reach a high level of stability and consistency in introducing and launching new patent protected products.
- Gilead Sciences needs a broad portfolio of products and has to avoid that single products become similar important as Harvoni and Sovaldi have been in the past. When a competitive advantage is based on patents, it is important that a company has several great patents and the loss of one patent is not immediately creating problems.
- And although it sounds horrible: For Gilead Sciences (and its investors) it would be better if its products only treat patients but can't cure them (yet).
Searching for companies with an economic moat around its business is one way to invest long-term. But of course, other companies can also be great long-term investments - despite the missing moat. But a moat adds consistency and stability and in case of Gilead Sciences we saw a steep revenue decline in the last few years (which is not really conveying consistency). However, over the last few quarters revenue stagnated and it seems like the revenue decline stopped and Gilead Sciences might have found its bottom. In the last quarter, total revenue was $5.3 billion, product sales were $5.2 billion and this was the first quarter in the past three years where the company could report year-over-year growth for the quarter and management is confident it can also grow product sales year-over-year on a full year basis. Earnings per share also declined since 2015. On a GAAP basis, Gilead Sciences had two quarters with either negative EPS (Q4/2017) or earnings per share of $0.00 (Q4/2018). But it seems like earnings per share also stabilize right now - especially non-GAAP EPS seems stable for the last few quarters and the decline stopped.
(Source: Own work)
Gilead Sciences is generating almost 75% of its revenue in the United States and about 15% in Europe. HCV sales were once responsible for most of the company's revenue, but are right now only generating about 15% of total revenue. On the other hand, sales from HIV products became more and more important for Gilead Sciences. One year ago, 63.3% of total sales stemmed from HIV products, right now 69.6% of total sales are currently from HIV products (in the first quarter of 2019).
(Source: Gilead Sciences Earnings Presentation)
It took several quarters, but it seems that Gilead is back on track and has new products on the market that can contribute to growth and will lead to increasing revenue and free cash flow for Gilead. Especially Descovy-based HIV products are increasing all over the world. Since the first quarter of 2018, revenue increased 43% for Genvoya, Odefsey, Descovy and Biktarvy. Especially the last one - Biktarvy - is a great success for Gilead Sciences so far. Revenue increased from $35 million in the first quarter of 2018 (during which it was launched) to $793 million last quarter and product sales are still increasing with a rapid pace.
Biktarvy has become the top selling product in the United States and generated $739 million in revenue. It remains the number one prescribed regimen in both treatment-naïve and switch patients, but approximately 80% of revenue comes from switches. Biktarvy is now also available in Germany, France and Spain and the launch in the United Kingdom and Italy is expected during 2019. In Germany and France, Biktarvy has quickly become the number one regimen for naïve and switch patients. In the past, peak sales were expected to be as high as $6 billion for Biktarvy and so far, the growth rates are impressive and should continue to rise in the coming quarters and years.
Yescarta is a second product which could reach peak sales above $2 billion according to analyst's expectations. In the first quarter of 2019, Yescarta generated sales of $93 million compared to $40 million in last year's quarter. In the past, management already mentioned that it would take some time to have enough centers certified to treat Yescarta-eligible patents in the United States. Right now, the number of treated patients increased to more than 1,500 in the United States and hospitals continue to learn how to operationalize CAR-T therapy and physicians' awareness of Yescarta is also improving. In Europe, Yescarta was approved in August 2018 and Gilead is continuing to build awareness about the therapy.
Additionally, Gilead Sciences has a rich pipeline with 30 product candidates right now - six of them currently in Phase III. One of those promising candidates in phase III is Filgotinib. The drug has several potential indications like Rheumatoid Arthritis, Crohn's Disease and Ulcerative Colitis and in March Gilead Sciences announced positive results from the FINCH program in rheumatoid arthritis. The three FINCH datasets (FINCH I-III) support the potential of Filgotinib as an important treatment option across the broad range of patient populations with rheumatoid arthritis. Another promising pipeline candidate was Selonsertib (NASH), but the last two studies (STELLAR-3 and STELLAR-4) did not meet expectations.
The decline in overall revenue and earnings per share that was caused by the declining sales of Harvoni and Sovaldi has finally come to an end as product sales from both are basically zero and can't decline any further. And with potential blockbuster candidates like Biktarvy (which generated already more than $1 billion in annual sales in 2018) and Yescarta (which will hopefully increase sales) should lead to an increasing revenue and increasing free cash flow in the years to come.
Intrinsic Value Calculation
Stabilizing revenue and earnings per share are good signs, that the decline is over and the company might have found its bottom. But an ending revenue decline is not enough to invest in a company. We also have to look at the company's intrinsic value to decide if it is a good investment or not. In the last 12 months, Gilead Sciences generated a free cash flow of $6,625 million (the lowest number since 2013) and I think it is reasonable to assume this to be the bottom and a realistic basis for our calculation.
When calculating with a 3% growth rate for the next five years as well as a 3% growth rate for perpetuity and take the free cash flow of the last four quarters as basis, we get an intrinsic value of $71.61 for Gilead Sciences (assuming a 10% discount rate). While a 3% growth rate for perpetuity seems realistic, a low single digit growth rate for the next five years might be too conservative. With Biktarvy and Yescarta adding to revenue and Filgotinib being in the pipeline to add to revenue in the coming years, a growth rate of 5% or even higher for the next five years is not excessive in my opinion. When assuming 5% for the next five years (and everything else being equal), we get an intrinsic value of $78.99; when assuming even 8% growth for the next five years we get an intrinsic value of $91.36.
A wide moat would also be important for the intrinsic value calculation as a wide moat ensures more stability and consistency to the business. While it seems possible to come up with realistic estimates for the next few years, it is almost impossible to guess a company's free cash flow correct in a decade or two. A wide moat simply adds stability and makes the process of estimating future cash flows a little easier, while in case of Gilead Sciences a similar scenario as in the last three years could happen again. And in this scenario even a conservative 3% growth rate would be completely wrong.
Although I wouldn't include Gilead Sciences in my wide-moat portfolio, I still think it is a good long-term investment at this point and with a positive catalysator (like results above expectations), it will climb higher again. We don't know when Gilead Sciences will break out of its sideway range, but in the meantime, investors can collect a dividend yield of almost 4%. And when Gilead Sciences manages to create a product portfolio of several patent protected products, which all contribute at similar levels to overall revenue it might also become a wide moat company and avoid a "Harvoni/Sovaldi problem" in the future.
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Disclosure: I am/we are long NVO, 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.