- The S&P 500 lost 10% since the recent highs as it looks like the number of ex-China Coronavirus cases is increasing exponentially. Many investors are questioning their investment strategy.
- In this article, I want to provide an interesting strategy which will protect your portfolio to a worsening of the virus situation while still being able to benefit from improvements.
- This strategy is based on buying Gilead, which will potentially be able to sell its Coronavirus drug Remdesivir in April, as its Phase 3 is initiated last week.
- In my case, if the Coronavirus situation worsens drastically and the market would crash by another 20%, my losses will be limited to 9%.
- Moreover, if you buy Gilead but the virus fades away, the company could still surge in the long term based on revenue growth expectations from new approvals. Buy Gilead.
There is a lot of uncertainty in the market that the number of Coronavirus cases will keep increasing exponentially. This could cost tens of thousands of peoples' lives and would impact the worldwide economy, which was already poor. Although the real consequences are still unclear, it will certainly keep the stock market low in the shorter term as fear is the stock market's worst enemy. As of March 5th, the S&P 500 (SP500) was down 11% from its recent February highs and down 7% YTD. Many investors are questioning the magnitude of the virus impact and its implications for the stock market. It is fair to assume that as a consequence of the big economic impact, as shown by the recent Chinese PMI which was lower than during the financial crisis, the stock market could fall by another 20% if this crisis intensifies. In contrast, if it fades away, the market could reach all-time highs soon, as general stock market fluctuations are hard to predict. How can we hedge our portfolio for a crash while still being able to benefit from an improvement? My answer is clear: buy Gilead (NASDAQ:GILD)! On the one hand, its drug Remdesivir has the highest potential to cure the Coronavirus. Consequently, the company could benefit from an exponential increase in the number of cases, which would lead to a higher stock price. Second, if the Coronavirus would fade away faster than anticipated, the stock could still gain significantly in the long term based on revenue growth anticipation from new drug approvals.
Different strategies: hard to take the good one
I've read a lot of different strategies on Seeking Alpha. First, you could just hold all your shares and try to buy more when the markets keep dropping. The problem with this strategy is determining a good entry point. Also, if this virus really becomes a huge problem and leads to a recession, this strategy could widen your losses even more. Second, you could sell a big chunk of your positions and hold much more cash than usual to buy when the real correction is done. However, almost no one can time the market perfectly and it is not sure at all that the market will drop even more. It is possible that the Coronavirus will fade away soon, and with anticipated rate cuts from the Fed, the market could rally to new all-time highs. Think about the investors who anticipated a recession in 2015 and missed all the gains until now. Third, you could hedge your portfolio by buying options (for example, puts on the S&P 500). However, this strategy is pretty expensive as option prices rose significantly due to a sharp increase in volatility.
Which strategy do I prefer? During the all-time highs, I advised investors to increase their cash position (for example here) slightly by selling overvalued stocks in their portfolio. Furthermore, I believe buying low-risk cash flow compounders such as J&J (JNJ), Intuit (INTU), Accenture (ACN), etc. with this cash is the right way to outperform a bear market while still being able to enjoy a further rally. I encourage following this strategy now by buying such high-quality stocks in small parts on further market weakness. However, this was my basic strategy to be prepared for a bear market, which didn't include an epidemic such as the Coronavirus. In this article, I want to add a very interesting stock which could benefit all investors by (partially) protecting the value of your long portfolio against a worsening of the Coronavirus: buy Gilead.
Gilead's Coronavirus drug Remdesivir: highest potential?
Gilead has worked on an anti-viral drug named Remdesivir for years now to treat similar viruses like the Covid-19. Originally, it was tested on Ebola in 2015, but two drugs seemed to work better than Remdesivir. However, Gilead knew that the drug is effective overall on viruses. The drug showed strong in-vitro results for SARS and MERS, both coronaviruses which are more similar to COVID-19 than Ebola. As mentioned during the recent Cowen conference, data from China demonstrated efficacy using monkey cells. Moreover, a study with the USA CDC will use human cells and we are awaiting data from them. Furthermore, there are two clinical trials ongoing in China, of which data is expected in April. Lastly, there are two phase 3 trials initiated by Gilead in March in several countries to evaluate the impact of 5-day and 10-day Remdesivir regimen.
Gilead's drug has two advantages compared to other companies reported to come with a cure for the virus. First, it is way ahead in time given that efficacy and safety has already been tested and that it is currently performing phase 3 trials, which is the last trial before approval. It is not 100% clear when Remdesivir will be approved, but it is fair to assume that the drug could be approved as early as April when the data shows strong efficacy. In contrast, current vaccines need to engage in much more studies before approval. For example, the process of testing and approvals for Moderna's (MRNA) vaccine would last at least another year. Second, Remdesivir is named by an official of the World Health Organization as the best shot to treat the virus.
There is only one drug right now that we think may have real efficacy and that's Remdesivir.
I hear you thinking, "It would take more than one month for a possible approval. At that point, there will be no patients anymore to treat and it will not have a material impact on its financials." I would like to contradict this with two statements. First, I believe that Gilead will benefit from this drug only if the Coronavirus will become a big worldwide crisis which will last longer than another month. It could be a hedge against a huge Coronavirus crisis, not against a virus which fades away quickly. Second, at this moment, Europe and the USA are in the same phase as China one month ago. As there are still many patients left today in China, it is reasonable to assume that there will be many worldwide patients to treat when the drug could be approved. In fact, as indicated on the graph below, the number of worldwide cases is growing exponentially compared to a linear growth for China. As such, I believe the circumstances ex-China will be far worse in a couple of weeks compared to China today. While this could be a disaster for the stock market, it could be beneficial for Gilead's financials. I rate the probability of approval at 90% given the WHO statement and Gilead's success in curing anti-viral diseases in the past such as HCV and HIV. Next, I will discuss why buying Gilead could be a good idea to protect your portfolio, as it could yield strong returns both when the Coronavirus disappears and worsens.
(Source: Robbe Delaet; based on Johns Hopkins data; Day 1 is February 19 for ex-China and January 25 for China)
How can buying Gilead protect your portfolio against Coronavirus?
Gilead has been an undervalued stock for years now, being valued at around 10x its free cash flows. In my recent article, I rated the stock as a buy, with a fair value of $116 (more information about this is provided in the next section). I indicated that Gilead only needs one positive to change investors' appetite for this undervalued stock. I suggested that this could be revenue growth from its anticipated new drug approvals in 2020 and beyond. However, it looks like its Coronavirus drug will be the event that improves investor appetite.
At the moment of writing this article, the number of cases is surging exponentially in Europe and the USA. It looks like these regions will be impacted even more than China. The more this situation worsens, the lower the overall stock market will go, but the higher Gilead will go as its drug (when approved) would have a much higher potential. To give an indication on the strength of this hedge, I included a portfolio with 20% cash, 10% Gilead shares and 70% other stocks (similar to my current portfolio). For this model, I assume that the market will crash by another 20% if the number of cases worldwide would keep increasing exponentially. Furthermore, I assume that Gilead will reach my price target of $116 because of optimism around the Remdesivir drug. Interestingly, instead of having a portfolio which goes down by another 20%, this portfolio would perform significantly better with a return of -8.7%
(Source: Robbe Delaet; Gilead upside based on price of $76 while writing)
Gilead's performance when the Coronavirus fades away: price increase expected in the long term
Of course, there is a possibility that the number of worldwide cases will not increase significantly, which could lead to new all-time highs for the S&P 500. Moreover, there is (a rather small) possibility that the drug will not get approved. Both cases could lead to a decrease in Gilead's stock price in the short term by at least 15%, bringing the stock back to its pre-Remdesivir levels. If this (unlikely) scenario would play out, my portfolio would gain only 5.5% compared to a 10% increase for the market. This underperformance would be rather small compared to the benefits in the other scenario.
(Source: Robbe Delaet)
However, in my opinion, Gilead shareholders could still see strong returns in the long term even if the Coronavirus weakens, which is an important factor for my bullish view on Gilead. While the Remdesivir potential would disappear, there are several catalysts which could increase the stock price in the long term. First, you have the very consistent, sustainable revenue growth from its HIV franchise. Gilead's HIV drugs grew by 14% CAGR and are expected to keep growing, given the recent approval of Biktarvy. Not one company has come close to competing with Gilead in this business. Recently, there have been concerns about competition from GlaxoSmithKline (GSK). However, the FDA has rejected the approval of its drug named Cabenuva, which is very positive news for Gilead.
(Source: Gilead's investor presentation)
Second, you have potential revenue growth coming from the Galapagos (GLPG) collaboration. Galapagos has several high-potential blockbusters in its pipeline, which could improve Gilead's sales significantly as it has the commercial rights. Filgotinib, a JAK-inhibitor for inflammatory diseases, is expected to be launched in 2020 and could reach peak sales of $4 bln. Moreover, you have GLPG1690, which is a high-potential candidate to cure the IPF (lung fibrosis) disease. The company recently started a phase 3 study, which is expected to read out in early 2021. This market currently has $2.1 bln in sales potential, which could increase drastically over the coming years. Other high-potential drugs are GLPG1972 for osteoarthritis and Toledo for inflammatory diseases. Lastly, Gilead acquired Forty Seven (FTSV) last week, which gives it the ownership of the potential blockbuster Magrolimab for treating several cancers. The drug could reach the market in 2020. Below, I included my estimations on revenue expectations, which are covered more thoroughly in my last article, including the discounted cash flow estimations which got me to a fair value of $116. Given Gilead's low valuation of 12x its free cash flows and anticipated revenue growth, I believe the stock could provide strong returns in the longer term even without taking Remdesivir into account.(Source: Robbe Delaet)
In my opinion, before the worsening of the Coronavirus, Gilead already was a very good stock to buy given its undervaluation, resilience to a recession, and anticipated revenue growth. Now that it will probably launch a Coronavirus drug in April, this stock becomes a hedge against a market crash on the Coronavirus. My model shows that taking a 10% stake in Gilead could limit the downside from -20% to -9% if the market crashes. When the virus fades away, Gilead is still a nice-to-have stock with the same 59% upside for the long term. My current strategy consists of holding Gilead (bought at $65) and adding qualitative cash flow compounders such as J&J, Accenture and Visa (V) to my portfolio on further market weakness. I anticipate that this will be a good strategy, outperforming a potential crash, but still being able to benefit from market improvements.
This article was written by
Analyst’s Disclosure: I am/we are long GLPG, 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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