As value investors, we rarely get a chance to buy dynamic biotech companies since they typically sell at 20x (or more) earnings. In the last two decades, in those rare cases where a biotech company has sold for under 10x earnings, we have ultimately done quite well on the investment. We think Gilead Sciences (GILD) represents one of those opportunities today and feel the stock is a "table-pounding" buy.
By simple valuation metrics, the shares are dirt cheap. The company sells at 6.6x 2016's EPS of $11.40, 6.9x 2017's EPS of $10.87, and pays a 2.5% dividend. Beyond selling at a great price, the company has leading drug franchises in the HIV and hepatitis C markets and has a respectable pipeline. It also has a solid balance sheet with $4 billion of net cash, strong free cash flow at $14 billion per year and a top-tier, shareholder-oriented management team.
A little color:
Gilead's revenues and profits have grown dramatically in recent years with the launch of Sovaldi and Harvoni. These have been wonder drugs that have been able to fully cure patients with hepatitis C infections in less than a year. As the business has matured and is in the gradual process of decline, investors have exited the stock.
However, we think the investment community has overreacted. For one, the hep-C franchise will still be a big producer of revenue in the coming years. It's not going to be the $15 billion drug franchise at its peak, but it won't go to zero. It should bottom out in the $8 billion to $10 billion range by the end of the decade.
On other fronts, the company has made great strides at enhancing its HIV franchise in recent years with the launch of newly updated therapies based on the TAF trials. These updated products should extend the life of the HIV franchise past previous estimates. GILD reported much-better-than-expected HIV revenues during the recent third quarter with sales coming in at $3.5 billion vs. $3.3 billion for the projections.
Moreover, GILD has several opportunities in its pipeline to materially add to revenues and earnings. The largest opportunity is bringing a hepatitis B therapy to market using NASH drug regimens. The company has several late-stage drug trials in hep B that can potentially amount to a multibillion-dollar drug franchise. To date, hep B is incurable and deadly.
Beyond this, management isn't just resting on its internal pipeline to bring new drugs to market. The firm is actively engaged and willing to make a string of acquisitions or even a larger acquisition to enhance Gilead's product portfolio. Based on its balance sheet and cash flow, GILD can easily consummate a deal or several deals valued at up to $30 billion without coming even close to stretching its finances.
Management is committed to taking actions that return Gilead to growth. When this does happen, the shares should meaningfully revalue from the current 6.6x to 6.9x earnings multiple to the low teens or even better.
Beyond this compelling investment case as an independent company, we also think there is an outside possibility that GILD could fall prey to a mega-sized pharma firm looking to steal the company.
Our fair value on GILD is well north of $110 per share, but would expect to review that price with an eye toward raising it, if the business progresses as we expect it to in 2017 or if the company makes a well-received acquisition, which would further boost long-term prospects.
