Lately, interest for Gilead (NASDAQ:GILD) stock has risen dramatically as a consequence of a potential launch of its COVID-19 drug named Remdesivir. I have been a long-term believer in this company. My investment thesis, also discussed in my December article, is based on three factors: its new management team, new longer term growth opportunities and significant undervaluation. Today, I want to reassess this investment thesis by discussing the impact of Remdesivir and other recent initiatives to create shareholder wealth. I believe that Gilead, led by a very competent new CEO, is undergoing great long-term initiatives which will benefit shareholders significantly. However, given the free-of-charge doses and long lead time for Remdesivir, I do not give a lot of value to these recent developments. For me, Gilead remains a buy based on future growth expectations from new treatment launches, excluding Remdesivir. The COVID-19 drug could just be an icing on the cake for shareholders.
Prior Gilead investment thesis
My prior investment thesis dates back from December 2019, discussing why Gilead could be a strong outperformer in the future. At that time, I was increasingly looking for 'safe' stocks which can withstand an economic downturn as this likelihood increased dramatically given the 10-year lasting bull market and increased risk taking.
My recommendation was based on three main factors:
First, Gilead significantly changed its leadership from an 'older' team which focused more on marketing developments to a younger, but extremely competent team with a renewed focus on medical innovation. They hired Daniel O'Day as CEO, who is a very competent leader with experience as CEO of Roche Holding (OTCQX:RHHBY). Moreover, Gilead hired Johanna Mercier as Chief Commercial Officer, who was a former executive at Bristol-Myers Squibb (BMY) and Merdad Parsey as Chief Medical Officer, former VP of Genentech. Together with this leadership change, Gilead also changed the strategy of its company. Before, Gilead was regularly accused of destroying shareholder value by not putting capital into work efficiently. For example, the Kite Pharma takeover of $11.9 bln was seen as too expensive and focused too much on the short term, while there was an increasing need for investments in longer term candidates. In 2019, the company strategy changed dramatically, focusing more on innovation and investments in future multi-billion drug candidates, which brings us to the second factor: longer term growth opportunities.
Since the change of Gilead's strategy and leadership, the firm engaged in two important deals with Galapagos (GLPG) and Forty Seven (FTSV), which together with the Kite takeover could create significant growth opportunities. The new collaboration with Galapagos, initiated in July 2019, is seen as a pioneering relationship. Gilead paid a total amount of $5.05 bln for the collaboration (75% of its yearly free cash flow). Galapagos stays completely independent as highly innovative biotech and will be increasingly focusing on developing new potential blockbusters. Meanwhile, Gilead will support their medical research and will build a commercial team around its new drug candidates. Filgotinib is the first candidate which should be introduced in the market for Rheumatoid Arthritis in mid-2020. The drug is researched for other inflammation indications as well such as Crohn's Disease and Psoriatic Arthritis. Altogether, analysts expect this drug to reach peak sales of around $5 bln (22% of current revenues). Furthermore, Galapagos has several promising candidates such as GLPG1690, GLPG1972 and Toledo which could become multi-billion assets for Gilead in the future. Important Phase 2/3 read-outs are anticipated for 2021 for these candidates. Also, Gilead acquired Forty Seven for $4.9 bln in March this year. Forty Seven is a highly innovative early-stage biotech company which focuses on Immuno-Oncology Therapies. Again, this takeover is based on huge longer term opportunities focused on R&D instead of short term sales. In fact, its leading candidate Magrolimab is currently in multiple phase 2 trials and would be able to reach the market at the end of 2022 in the most positive scenario. Peak sales could reach as much as $2.9 bln for this drug.
With these two strategic initiatives, Gilead widens its leadership from anti-viral diseases to inflammatory diseases and immuno-oncology as well, which could benefit shareholders in a major way. Its current R&D investments together with these new initiatives should make it possible to deliver on its medical guidance to bring 10+ transformative therapies to patients by 2030. Below, you can observe my revenue expectations, clearly indicating that revenues from newly introduced candidates could significantly outweigh the anticipated loss of revenues in 'older' drugs for HIV and HCV. The assumptions are thoroughly discussed in my recent article. Note that this model is incomplete as it does not include less predictable sales such as HBV sales (expected to reach $1 bln in 2022) and Toledo (could be introduced as early as 2025 and is expected to have even higher potential than Filgotinib).
(Source: Robbe Delaet expectations; figures in $mln)
My third and last factor in my investment thesis included Gilead's significant undervaluation. In December, Gilead was valued at a depressed FCF yield of 10% and a dividend yield of 3.80%. In fact, I estimated its fair value at $116, which implied 77% upside at that moment. I believe that this undervaluation was caused by a very negative sentiment around sales (which declined from $32 bln in 2015 to $22 bln in 2019 due to a strong decline in HCV sales). At this valuation, I mentioned that any positive news could dramatically increase its stock price, which brings us to... Remdesivir!
Potential of its COVID-19 drug, Remdesivir
Early February, Gilead became on the radar by news about the possible market introduction of a COVID-19 treatment, named Remdesivir. The drug was already tested for Ebola and for other coronaviruses such as SARS on animals with positive outcomes. As a consequence, it only needed positive phase 3 results on humans, possibly making it the first drug on the market for COVID-19. When the pandemic started in China, Gilead immediately took initiatives to start new trials and increase the supply of Remdesivir.
In March, I wrote a second article covering Gilead, calling it an interesting hedge for a worsening of the virus. I recommended Gilead as it still was undervalued and could gain dramatically if the virus worsens and Remdesivir would be introduced on the market. Since this article, the stock gained by another 9%.
Over the last week, much news came out about the efficacy of the drug.
- Positive primarily data was provided by the NIH NIAID trial, researching efficacy in critical patients. Results indicated that patients who were treated with Remdesivir had a 31% faster time to recovery than those who received placebo. Importantly, this was statistically significant with a p-value of 0.001. Slightly positive survival benefits were also observed with a mortality rate of 8.0% for the group receiving Remdesivir versus 11.6% for the placebo group. However, this result was not statistically significant (p-value 0.056), although very close.
- Gilead initiated a study, called SIMPLE, as well to research the efficacy of a 5-day treatment compared to the 10-day study. Results indicated no significant difference between a 5-day treatment and 10-day treatment. This is positive news as this means that Gilead could provide treatments for double the amount of patients than anticipated. 70% of the 5-days treated patients recovered compared to 59% for the 10-days treatment, while 8% and 11% of patients died respectively. This study was not placebo-controlled and thus tells us few about the actual efficacy of the drug.
- Relatively negative news came from the Chinese trial, also reported by "The Lancet". Patients receiving Remdesivir had a numerically faster time to improvement compared to placebo, but this was not statistically significant. Moreover, the number of deaths was comparable to placebo. It is important to note that the number of patients in this study was significantly lower compared to the NIH NIAID study (n=237 vs. n=1053). As a consequence, these results could be impacted significantly by coincidences rather than the real impact of the treatment.
(Source: Gilead's Q1 2020 presentation)
Overall, the results were positive and should be sufficient to lead to a market approval in the coming weeks. While this could be very positive for humanity, I am more skeptical on the financial benefits for Gilead, which ultimately is what investors should look out for. First, the drug is not easy and time-expensive to manufacture (178 days). In its Q1 earnings call, Gilead stated that it expects to have 140,000 treatments (280,000 when the 5-day treatments would be used) available at the end of May and 1 million at the end of 2020. Thus, for Remdesivir to have a material impact on Gilead financials, there would have to be a second wave of virus cases. Second, Gilead will provide all the current supply of 140,000 doses at no cost which reduces financial benefits significantly. As a consequence, the treatment will only be beneficial for Gilead if the virus looks to become seasonal. This is also mentioned in a recent Morningstar analysis:
We assign remdesivir a 70% probability of approval in 2020 as a treatment for COVID-19, but we assume a 40% probability of bigger sales in 2021-23 as governments stockpile the treatment, if the disease looks like it might become seasonal. We assume peak sales of $1.4 billion in 2021, as we expect progress with a vaccine could limit long-term sales potential.
CEO O'Day stated during the recent conference call that the developments are too premature to determine the possible impact on revenues.
(Source: Gilead's Q1 2020 presentation)
Gilead's Q1 2020 results
Apart from the Remdesivir noise, Q1 results reaffirmed my investment thesis. Product sales increased by 5% YoY, positively impacted by HIV and Yescarta sales and negatively impacted by HCV sales and other products. Biktarvy, the leading treatment for HIV, sales grew by 113% YoY as a consequence of a higher adoption rate. It is expected that Gilead will be able to maintain its leadership in HIV over the coming years, which will generate significant cash flows for shareholders. Expenses, primarily related to Remdesivir, grew at a similar rate to sales, which resulted in flat EPS growth year over year.
(Source: Gilead's Q1 2020 presentation)
R&D advancements are all evolving according to plan with Filgotinib expected to launch for RA in 2020 and in five other indications over the coming four years. Yescarta is seeing slow, but steady growth which is expected to continue as new approvals kick in. 2021 will be a major year for Gilead as GLPG1690 phase 3 results will indicate its full potential. This could increase upside significantly as my peak sales estimates range from $1 bln all the way to $9 bln on positive results. Moreover, interim phase 3 data from Magrolimab and several phase 2 results from Toledo are anticipated, both potential multi-billion assets.
(Source: Gilead's Q1 2020 presentation)
Also interesting to note is the fact that Gilead intensified its share repurchases to approx. $1.3 bln during the first quarter compared to $100 mln during Q4. There is $7.1 bln remaining under its current share buyback program. The company kept its dividend stable at $0.68 per quarter, implying a current dividend yield of 3.20%.
Conclusion and investment update
To conclude, Remdesivir looks to have a high probability of approval given the recent positive read-outs, which is amazing news for humanity. However, shareholders need to take into account that this will have a minor impact on profits as the company will provide the current supply at no cost and future supply will take much time to manufacture. I believe that this virus will need to occur on a seasonal basis to generate significant profits for Gilead. More important for Gilead's future value are the developments around Yescarta sales, Galapagos' and Forty Seven's drug candidates. These developments are going well and I expect future drug approvals to increase Gilead's revenues by approximately 40% over the coming years, which could increase on future positive read-outs. Given this possible growth acceleration, I believe Gilead is undervalued at a P/E of 17, FCF yield of 7% and dividend yield of 3.2%. I anticipate that the investor appetite for Gilead will increase dramatically and maintain my fair value estimate of $116, implying 38% upside. Long-term investors could try to buy the stock on weakness below $80. Gilead remains a strong hedge against a new wave of the COVID-19 virus potentially hitting in the fall.
