- The first presidential debate concluded without any reference to the biotech sector.
- While Gilead's declining sales are still a concern, they may be bottoming out.
- Strong fundamentals, cheap valuation and huge upside makes Gilead stock a good buy.
Investors in Gilead Sciences (NASDAQ:GILD) and biotech heaved a sigh of relief as the first presidential debate went on without any mention of the biotech sector. The biotech sector has been taking a lot of heat for what many call as "price gouging". Gilead stock has taken a strong beating in the past one year due to declining sales and political risks. But this decline has created an opportunity for value investors. The company has strong fundamentals and a solid pipeline of drugs. And the valuations are compelling. But on the downside, Gilead's sales are declining while the company has not been able to make any acquisition capable of driving its growth. The company also carries a political risk concerning its pricing policies. The concerns regarding the declining sales and the political risks have been weighing heavily on Gilead stock.
Gilead Is Priced In For Negative Growth
A DCF valuation of Gilead shows that the stock is priced in for negative earnings growth over the next five years, which is a very pessimistic view. With a risk-free rate of 1.5%, an economic risk premium of 6.12% and a beta of 1, cost of equity for Gilead sciences comes in at 7.62%. The cost of debt for Gilead is around 4%. The WACC comes to around 7% and Trailing twelve month (TTM) FCFF is $17 billion. Using next five years growth rate of -0.2% (which according to Yahoo finance is wall street's expectation for Gilead's earnings growth over next 5 years) and perpetual growth rate of 1.5%, Gilead's market cap comes to around $114 billion, around 7.5% higher than the current market cap of $106 billion.
Strong Profitability And Cheap Valuations
Gilead has strong profitability with an operating margin annualized of 65% and net margin coming in at 45%. Gilead's return on equity (ROE) is very strong at 97%. When compared to the cost of equity of 7.6%, Gilead's ROE more than adequately rewards the investors for their risks. And the company generates billions in free cash flow every quarter. But in spite of such strong fundamentals, the company is trading at a PE(TTM) of 7.08 and forward PE of 6.94 (from yahoo finance). In addition to strong fundamentals and cheap valuation, Gilead stock has a healthy dividend yield of 2.3%.
The two main risks surrounding the stock are the declining sales of the hepatitis C drugs and the political risk of action against price gouging. So let’s discuss the declining sales. For past few quarters, the investors have been worried by the declining Hep C drugs which have raked in billions of dollars for Gilead. In the latest quarter, the revenue from these drugs declined by $900 million to $4 billion, an 18% decline. The decline has been mainly because of competition from Merck (NYSE:MRK) and AbbVie (NYSE:ABBV) which have brought in cheaper alternatives. But the decline is likely to bottom out as there is enough room for growth for all the competitors and also the demand for Gilead's new drug, Epclusa, is likely to pick up. Analysts project that Epclusa could generate sales of over $10 billion as early as next year. According to a report on Barron's, the HCV sales might already be getting better. To quote the report:
Notably, HCV franchise is seeing some uptick in last 5-6 weeks as NRx (new starts) are tracking slightly better than the beginning of the quarter. In the month of July’16, NRx were light by 12% vs. April’16 (QTD). This has now improved and NRx till 9/16 are only down by 7% QTD over last Q. In the month of August and September (so far), new starts are only down 4% QTD over last Q.
Also, Gilead has a strong pipeline of drugs. And its HIV drugs continued to post strong numbers in the second quarter.
Biotech has been getting a lot of bad press lately for what many call “price gouging”, be it related to EpiPen or Valeant pharma. And many politicians including Hillary Clinton have promised to take action against such behavior. Last year in September she had tweeted "Price gouging like this in the specialty drug market is outrageous". She has detailed a three-pronged strategy including fines to tackle this issue. And this has been weighing down on the biotech sector. While it must be a relief to many biotech investors that the first presidential debate went on without any mention of “price gouging” the political risks still prevail, though they might have eased temporarily.
Gilead Stock Performance
Gilead stock has disappointed investors in the last one year. The stock has declined by 15% in the last one year compared to a 16% increase in Nasdaq and 2% gain in biotech ETF iShares NASDAQ Biotech Index ETF (NASDAQ:IBB). The stock is down around 20% this year (YTD). However over the last five years, Gilead stock has handsomely beaten both the Nasdaq and biotech index. Gilead stock has returned more than 300% while Nasdaq has returned 215% and IBB has returned over 100%.
The average analysts target price is $104.5 which represents a solid 30% upside from Yesterday’s closing price. And add to that, the stock is currently yielding a decent 2.3%.
Gilead Stock Looks A Good Buy
After taking a heavy beating over the last one year, Gilead stock is poised to rise. The declining sales of its Hep C drugs have been casting a shadow over the stock. But the decline is likely to bottom out in coming quarters. Epclusa and HIV drugs will continue to drive growth. On the technical side, Gilead stock is currently finding a support at the 50 day SMA. If the support level holds firm, then the stock will face its next resistance at the 100 day SMA. With strong profitability, good dividend yield and cheap valuation Gilead stock looks an attractive buy. Analysts estimates indicate an upside of more than 30%.