Gilead Sciences (GILD) stock has been range-bound for the better part of 12-months, despite the incredible performance of its two hepatitis C drugs, Harvoni and Sovaldi.
Investors have discounted the strong performance of these two drugs because their success has limited a lifespan, and because there’s nothing to replace those drugs when sales start to decline fast.
As a result, there’s not much to get excited about when GILD reports earnings on Tuesday.
Harvoni and Sovaldi Continue to Yield Great Results
The bottom line is that major indices are essentially flat since Gilead Sciences’ previous earnings report. And despite GILD completely crushing expectations, GILD stock is trading 11% off its 52-week high because investors overreacted to a safety warning by U.S. regulators on HCV competitor AbbVie’s Viekira Pak and Technivie.
What investors failed to realize is that AbbVie’s HCV drugs were never recommended for patients with severe liver diseases. Hence, they’re not particularly threatening to Gilead Sciences.
GILD’s Harvoni and Sovaldi dominate the HCV market. The two drugs created revenue of $4.89 billion during GILD’s June quarter as both U.S. and international markets performed very well.
In total, GILD’s revenue jumped 26% year-over-year to $8.2 billion. Its HCV franchise accounted for nearly 60% of total revenue. The effect of this strong performance forced GILD to up product sales guidance by $1 billion for the full year, to $29-$30 billion.
The Problem for GILD stock
All things considered, GILD had a lot of good news from its June quarter, yet investors are already starting to look ahead, and for GILD stock, that’s a problem.
For the thirdquarter, analysts expect revenue of $7.82 billion. While GILD will likely exceed expectations, HCV franchise sales will still see a sequential decline. This means that Gilead’s HCV franchise has likely peaked, something that was expected after the first quarter.
Nevertheless, investors now expect blockbuster results from Harvoni and Sovaldi, and are now looking ahead to the day when Harvoni and Sovaldi’s addressable market diminishes. GILD needs to find the next big thing to support its valuation.
Currently, Gilead’s HCV franchise accounts for nearly 60% of the company’s revenue, most of its profit, and thereby the majority of its $160 billion valuation. While GILD stock looks cheap at just nine times this year’s expected EPS, investors must remember that Harvoni and Sovaldi are cures to HCV, and eventually that market will diminish.
Sales have peaked, which means Gilead will not produce rapid top-line growth from this point forward. In fact, total revenue is expected to fall 1% next year.
What Gilead Needs to Do
Harvoni and Sovaldi will continue to drive big profits for Gilead. Prior to 2014, Gilead’s free cash flow hovered around $2.5 billion a year, but is now near $18 billion for the trailing 12 months. That’s great and all, but what investors want is for GILD to put that money to work, and find the next Pharmasset — the acquisition that led to Harvoni and Sovaldi.
With that said, Gilead Sciences has mountains of cash that keeps on growing due to its cash cow HCV franchise. Even though Harvoni and Sovaldi have peaked, they will still generate billions of annual FCF for several years to come.
Still, a $150 billion valuation is a big number, especially when investors can’t see anything down the road to spark growth once Harvoni and Sovaldi sales decline.
That’s why Gilead needs a big acquisition to boost GILD stock. That’s also why GILD stock looks so cheap but can’t seem to break through current level. Gilead Sciences needs to make a splash. It needs to do something like Celgene (CELG) did by acquiring Receptos. Or it could enter a new space entirely, buying a company like Acadia Pharmaceuticals (ACAD) that might have the most underrated anti-psychotic drug of all-time.
Gilead Sciences needs to something that solidifies the next 5-10 years. Until then, $150 billion is probably an appropriate market cap, and GILD stock is unlikely to go much higher. In other words, if GILD blows through third-quarter expectations and produces blockbuster numbers like last quarter, expect mid-single digit gains like we saw in the June quarter.
But, if Harvoni and Sovaldi disappoint, don’t be surprised to see GILD stock react harshly.
As of this writing, Brian Nichols owned shares of ACAD and CELG.