Gilead Sciences, Inc. (NASDAQ:GILD) has put together a nice run of late. The GILD stock price today sits 24% higher than it did as recently as June, when the stock hit a three-year low.
There is some good news here. As InvestorPlace’s Chris Lau pointed out, the acquisition of Kite Pharma and its CAR-T therapy makes some sense, and was met with analyst optimism. Also, InvestorPlace writer Luke Lango made a broader case for upside in the GILD stock price earlier this month. Both of my colleagues make good points and Gilead stock looks cheap, trading at less than 11x forward EPS.
But I’m not buying the rally in GILD stock. As a company, I like Gilead, and its efforts to battle hepatitis C and HIV are commendable. But as a stock, GILD isn’t as cheap as it looks, particularly when considering the broader pressure on the pharmaceutical and biotech industries. There’s one key problem that means GILD likely should only be bought at a huge discount. And I don’t think that discount is quite big enough at the moment.
Kite Looks Like A Decent Purchase…
The approval of Yescarta, Kite’s flagship therapy, no doubt is good for GILD stock. CAR-T is a cancer treatment that uses modified versions of existing T-cells (a type of white blood cell) to create modified versions that will attack cancer cells.
It’s a promising therapy — and potentially a lucrative one. As Barron’s pointed out, Kite will charge $373,000 — a huge number, but one that’s still more than $100,000 less than the existing therapy from Novartis AG (ADR) (NYSE:NVS). But from a profit standpoint, there are concerns.
Notably, competition will be intense. James Brumley laid out the bull case for Juno Therapeutics Inc (NASDAQ:JUNO) back in August, citing its CAR-T potential. ZIOPHARM Oncology Inc. (NASDAQ:ZIOP) and bluebird bio Inc (NASDAQ:BLUE) are among myriad other smaller players working in the space.
In addition, the market may not be that big — at least at first. Analyst Geoff Porges, as quoted by Barron’s, estimated just 5,300 potential patients in the U.S. That will expand over time, as the therapies improve and indications broaden. But investors expecting a major short-term profit boost from Kite will be disappointed.
Meanwhile, Gilead paid $12 billion for Kite. But it has a market cap over $100 billion — and has added $20 billion-plus in equity value in just the last few months. Even if Kite is a winner, it may be priced into the Gilead stock price today already, or at least to the point where it’s not a major mover for GILD going forward. The bull case here still rests on the legacy business — and that creates one major problem.
…But Gilead Is A Declining Business
That problem is that in 2016, according to the 10-K, 50% of Gilead revenue came from HCV treatments and another 43% from HIV therapies. Both those markets, particularly the HCV product lines, are in long-term decline.
To be sure, that’s wonderful news for customers, particularly those with potentially fatal hepatitis C. But it’s a long-term profit problem for Gilead. The upfront cost of Sovaldi and Epclusa is staggering but a 90%+ cure rate also implies a steadily shrinking customer base.
Again, from a societal standpoint, that’s a good thing. For the Gilead stock price, perhaps not so much. And it goes against the argument that GILD is somehow “cheap.” Drugmakers typically are cheap, because profits from specific drugs tend to peak early and then decline, falling much faster once patents expire. (Hence the oft-discussed “patent cliff” earlier this decade, when a number of blockbuster drugs saw generic versions.)
11x EPS for a drugmaker with 90%+ of revenue (outside of Kite) coming from shrinking markets isn’t exactly a great deal. It’s a valuation that implies that profits will decline over the long-term — which seems the most likely outcome.
Bear in mind that both Teva Pharmaceutical Industries Ltd (ADR) (NYSE:TEVA) and Valeant Pharmaceuticals Intl Inc (NYSE:VRX) both trade at under 4x forward earnings. It’s not an apples-to-apples comparison between those stocks and GILD stock, obviously: Both Teva and Valeant have far more onerous debt loads, for one. But the multiples show the kind of pricing that’s possible for drugmakers whose futures are uncertain.
And Gilead’s future is uncertain. It’s not nearly as murky as those of its indebted rivals. But there’s a lot of reliance on Kite (and likely future M&A) to create growth — a significant risk. GILD stock might look cheap but it’s most likely a declining business. As such, it should be cheap.
As of this writing, Vince Martin has no positions in any securities mentioned.