by Clement Thibault
Gilead Sciences (NASDAQ:GILD), a global biopharmaceutical company, reports Q2 results on Monday, after the close.
1. Revenue and earnings forecast
Gilead Sciences' forecast for Q2 is $3.02 EPS on $7.83B revenue. Should Gilead meet this EPS forecast, it would indicate that the company hasn't grown its EPS this past quarter—the first time since 2013. Gilead had a spectacular 2015, beating EPS estimates by 10% or more each quarter. In Q1 2015, the company reported EPS of 2.94 vs 2.32 expected, which made for a very welcome 26% upside surprise. Unfortunately, so far, 2016 hasn't been nearly as impressive. Reports for Q4 2015 and Q1 2016 beat EPS estimates by a paltry 1%, at $3.03 per share. The slowdown is also reflected in its current share price: $86.55 as of Friday's close, a far cry from its all-time high of $123.37 during June 2014.
2. Hepatitis C: GILD's core business
Right now, the two major diseases treated by Gilead's medicines are HIV and Hepatits C. Its two biggest products, both blockbusters, are Hepatits C (HCV) medications, Sovaldi and Harvoni. Together, these meds account for almost half of the company's revenue.
Understandably, during Monday's report the focus will be on their recent performance. In Q1, Gilead's HCV product sales fell by 6% year-over-year, to $4.3B. The problematic market for Gilead is the United States.
For the better part of the past three years, Gilead had a monopoly in the field of HCV drugs, which allowed it to accrue uncontested profits. At the end of April however, AbbVie Inc (NYSE:ABBV) launched its competitive HCV drug, Viekira Pak, which followed Merck's (NYSE:MRK) competitive offering, Zepatier, launched at the beginning of the year. The increased competition led to an inevitable loss of market share and a price war; Harvoni sells for 94K for the length of the treatment, Sovaldi for 84K, while Merck's Zepatier costs 54K for the identical course.
All three companies are applying for approval in China, where it is estimated that 10 to 20 million Chinese citizens have Hepatitis C. Perhaps more significant in the short-term, on June 28 the FDA approved Epculsa, Gilead's newest HCV treatment, which is effective for all six major forms of HCV – the first of its kind. For comparison, Harvoni is used primarily to treat genotype 1, the most common form of Hepatitis C in the US and Europe.
Because of the recent introduction, the new drug's financial impact won't be visible in the coming report, but its longer term effect could be significant in upcoming quarters.
3. Balance Sheet and Valuation
Perhaps one of the most compelling reasons for owning Gilead is its strong balance sheet. The $115B company has over $21B in cash assets, and is engaged in a stock buyback program which has taken over $8-billion worth of shares out of circulation. Its current liabilities are under $11B, which means Gilead has a ratio of Cash/Current Liabilities of almost 2. Pharmaceutical giants GlaxoSmithKline (NYSE:GSK), AbbVie and Merck all have a ratio of below 1.
The company's operating income for Q1 was $4.6B on $7.8B total revenue, meaning its operating margin is 59%, which compares very well against Merck's 17% or AbbVie's 37%. As of today, the company has a very low P/E ratio of 7.4, significantly less than the industry average of 40. As if these numbers weren't impressive enough, the company also has over $17.7B of free cash flow, which means it trades at under 7 times its cash flow.
During June 2015, Gilead started handing back some of its excess cash to investors in the form of dividends. The dividend, which began as a quarterly $0.43 payout, grew to $0.47 – a 9% increase – as recently as last month. With its current cash situation, it looks as if GILD will be able to grow its dividend when and as it wishes for the foreseeable future.
4. Developments in the R&D pipeline
Stock prices often reflect future expected value, rather than present worth. For pharmaceutical companies, their R&D pipeline may arguably be just as—if not more—important than their current product lineup. If that's the case, what's in Gilead's pipeline? We've already mentioned Epculsa, above, which is expected to reclaim at least some of Gilead's lost HCV revenue. GILD's next big prospect is Simtuzumab, which is currently in a phase 2 study. The drug aims to treat nonalcoholic steatohepatitis (NASH). If approved, it is expected to generate well over $10B in annual sales. Behind these two products, Gilead has seven late-stage clinical trials and 16 additional phase two studies in the works. While its R&D expenses, at $3B annually, are lower than Merck's or AbbVie's, they are on par with similarly sized GlaxoSmithKline, which indicates there's no scrimping at Gilead's end.
Conclusion
Gilead currently generates over $32B in annual revenue. It can no longer be considered an up-and-comer, as its share price has already exploded from the mid-30s in late 2012 to regularly being priced at over $110, which happened in 2014 and 2015.
Both its current performance and future prospects are looking good. Why then is it so undervalued?
With a P/E ratio of 7.4, it appears the market is discounting any future growth, and may have already priced in a decline in profitability. We believe this is an incorrect assessment of the company and its potential.
An alternative explanation could be that unfortunately Gilead has been dragged down by the pharma sector as a whole. As evident by the current performance of the popular SPDR S&P Biotech ETF (NYSE:XBI), which is now trading at $59.35—well below its all-time high of $91.1 a year ago—the entire sector is still hurting, nor has it recovered from the early 2016 Valeant (NYSE:VRX) price-gouging fiasco which pulled the sector down significantly.
Notwithstanding all of the above, we believe it’s merely a matter of time before Gilead's share price recovers. The company's revenues are immense, its operating margin is extraordinary, cash is flowing freely, and the company is buying back stock.
The way we see it, Gilead is like a high-end race car, spinning its wheels at the starting line, held back only by the weight of the sector in which it operates. Once that drag is removed, we believe it will take off at top speed, potentially leaving at least some competitors in the dust.