Gilead (GILD) is one of the country’s largest biotechnology firms. It originally rose to prominence with successful HIV drugs. Then the company made a game-changing acquisition, boldly spending $11 billion to buy Pharmasset in 2011. It was a make or break bet on that firm’s HCV drug pipeline, and it paid huge dividends for GILD stock owners.
GILD stock soared from $20 to as high as $120 following the deal. The HCV products, principally Harvoni and Sovaldi, have caused Gilead to experience tremendous growth in recent years. However, that growth has slowed, and GILD stock has begun to struggle. After topping $120 last summer, shares have slumped to below $90. Last week’s disappointing earnings report triggered a significant tumble. Is it time to buy GILD stock now or wait for lower prices?
GILD Stock: Pros
Low P/E Ratio: The main bullish argument for Gilead is that it’s cheap. And if you judge companies by P/E ratios, it certainly does seem that way. GILD stock currently trades at a 7 P/E ratio, its $85 stock price supported by $12 of earnings per share. Even with earnings growth stalled out at present, that’s still an attention-grabbing figure.
Additionally, the company is turning those earnings into real cash flow. In 2014, the company generated more than $12 billion in cash flow from operations. That figure spiked upwards to $20 billion in 2015. Prior to the launch of the HCV products, the company had never generated more than $4 billion in yearly cash flow from operations. For the time being, the HCV products have generated a veritable geyser of profits and cash flow.
Strong Shareholder Yield: As mentioned above, Gilead is generating mounds of cash. And they aren’t piling up in the company’s vault; Gilead is aggressively returning profits back to shareholders. At the current forward dividend rate of $1.88, the company yields 2.2%. That’s nice for a biotech firm, and represents more than $2.5 billion in cash that Gilead is returning to its owners every year.
Even more impressively, Gilead is engaged in a truly gargantuan share buyback. The company bought back almost 10% of its outstanding shares in the past year alone. Shares out dropped from 1.5 billion at the end of 2014 to 1.37 billion today. For long-term GILD stock holders, Gilead is greatly strengthening your ownership position in the firm through this aggressive buyback. It’s not new behavior either; Gilead has been steadily buying back shares since 2008. At one point, Gilead had 1.86 billion shares outstanding; it’s reduced that by almost 500 million shares over the years.
Acquisition Possibilities: Gilead made itself into what it is today with the bold Pharmasset purchase. Before that, it was one of the better biotech firms but it took that deal to bring it into the top tier of firms. Unfortunately for Gilead, by the time cash started flowing from the HCV drugs, the biotech sector had soared. This made it expensive to try to purchase the next company to grow their pipeline.
All that’s changed since mid-2015. The combination of political scrutiny toward the sector, Martin Shkreli’s escapades, a few key drug trial failures, and investor fatigue has sent biotech shares plunging. From peak to trough, the sector has fallen between 40% and 50% depending on which biotech index you track. For Gilead, this offers it the opportunity to buy other biotech firms at close to half price versus last year’s valuation levels.
GILD Stock: Cons
Collapsing Biotech Bubble: The positive above relating to acquisitions comes with its own built-in negative. Biotech stocks are diving, and Gilead is not immune. Even with GILD stock at its all-time high, above $120 per share, investors could make a decent case for it being “cheap” based on P/E ratio and cash flow, as I’ve done above. But that didn’t protect GILD stock from the coming biotech storm.
Since its peak, Gilead’s P/E has fallen from 11 to 7. A discounted valuation can get even cheaper during a broad market storm. A popular Wall Street adage holds that a stock’s sector, rather than its own individual fundamentals, drives the majority of performance. With biotech heading downward, it’d be asking a lot for GILD stock to buck the trend. The drivers of the biotech bear market: political scrutiny, pricing pressure, and widespread drug trial failures are all likely to persist in coming months.
Gilead’s Lead Drugs Are Peaking: Gilead now relies on its HCV franchise of drugs to produce the majority of the company’s revenues. These are unusual drugs, as far as the biotech sector goes, because they cure rather than treat symptoms of the underlying disease. While this is fantastic from the patient’s point of view, it is less so for the investor’s returns.
You see, Gilead has already made great headway in treating the easiest patients. These are the ones in developed US and Europe who have the cash or insurance to pay full price for Gilead’s drugs. This pool of infected patients capable of paying sticker price steadily shrinks. Gilead is forced to turn increasingly to emerging markets, such as China and India, which have less respect for patent law or western pricing schemes. Additionally, in the US, Gilead will increasingly find the patient pool consisting of drug users (HCV is often spread through contaminated needles). There will be less political pressure for this class of patients to receive the drugs at high cost to the general taxpayer.
Declining Earnings: Gilead’s earnings appear to have reached their top. Analysts had already been expecting little to no earnings growth in 2016 and 2017, and last week’s quarterly results did nothing to change that perception. The company missed badly on revenues and earnings, with sales of the HCV drugs coming up short of hopes.
The company’s net income fell to $3.6 billion for the quarter, down from $4.3 billion for the same quarter in 2015. Earnings per share were down, though by a lesser percentage. That share buyback does a lot to blunt the hit of falling income to earnings. Regardless, the peak in HCV sales, and thus earnings, appears to have arrived.
GILD Stock: Verdict
With declining earnings and not much in the near-term pipeline to generate meaningful new revenues, look for investors to lose patience with GILD stock. The huge drop on quarterly earnings is a clear sign of that.
For long-term investors, there’s real value here. If I had to put a price on it, I’d say $90 was fair value for GILD stock, and it’s below that now. However, given the political uncertainty, poor 2016 earnings outlook, and general woes in the biotech market, shares could well drop a good deal more before bottoming. I’d stay away for a few more quarters.
At the time of this writing, Ian Bezek had no position in GILD stock. You can reach him on Twitter at @irbezek.
