It is hard to look at a 1 year chart for pharmaceutical and bio-tech company Gilead Sciences (GILD) without feeling that you have missed the boat (see below).
A 66.9 percent increase since the low on August 15th last year would certainly suggest that, but when other things are factored in, you can actually make a case that far from being maxed out, GILD is still seriously undervalued.
The price of a stock is, in essence, simply a reflection of a company’s earnings and perceived earnings potential. On that basis, GILD has actually lagged results and is cheap. If a price increase of two thirds is based on speculation that one day a company will be profitable, or maybe more profitable than it is now, then after a year like this most investors would be in “show me” mode. Future growth would be priced in and I for one would be looking for some execution before doing anything.
GILD’s rise, on the other hand has been based on actual, achieved results and it looks like the market is struggling to keep up. The last two quarters’ earnings for Gilead have shown significantly more that a 66.9% increase year on year. Q1 2014 saw an increase in EPS from $0.43 in the same quarter of 2013 to $1.33, or a 209 percent jump. Q2 was even better, with EPS jumping from $0.46 to $2.19, a 376 percent increase.
I have, in the past, pointed to P/E and PEG ratio as the two fundamental measures of value when analyzing a stock, and by either of those metrics, GILD is a steal. The forward P/E, based on analysts’ estimates for the next 12 months of earnings, is 11.25, significantly lower than the average for even the S&P 500 which is currently 16.1, let alone the better comparison, the Nasdaq 100, which is at 18.65. The PEG ratio factors in projected growth, and on that basis, GILD, with a PEG of around 0.5 also looks extremely cheap. A word of caution here, though; that PEG is based on the last 12 months earnings, two quarters of which are from before the EPS of Gilead exploded, so it may be a little misleading.
That earnings explosion was in part down to approval for and success with Sovaldi, an oral treatment for Hepatitis C that has a 100 percent success rate. At $1,000 per pill and $90,000 for a full course of treatment, Sovaldi is extremely expensive, but the success so far demonstrates once again that, when it comes to healthcare, people, unsurprisingly, aren’t price sensitive. You can debate all day the political implications of that, but it won’t make it any less true.
What last quarter’s reported $3.48 billion in Sovaldi sales tells me is that Gilead Sciences can execute as well as innovate. In any business execution is important, but in a pharmaceuticals industry dominated by a few big players it is also quite rare. There are other drugs in Gilead’s pipeline, as indicated on the company's website, and results for them will probably be mixed if the history of pharmaceuticals in general is any guide, but the company’s proven ability to execute on the successful ones makes that pipeline more valuable than is the case with many biotech companies.
Almost every measure you look at confirms that GILD is enormously successful and still undervalued despite that 1 year run up. An operating margin of over 56 percent and a return on equity of over 53 percent show that management are effective and making the most of their success. If I were to search for a negative on the balance sheet it would be a debt/equity ratio of over 57, but with total debt standing at $9.50 billion, but with nearly $9 billion of cash on hand and levered free cash flow of $5.85 billion, even that isn’t a worry.
That cash position also means that replenishing the pipeline, whether by innovation or acquisition, shouldn’t be too much of a problem. There have been rumors around for a while that Gilead was looking to acquire Intercept Pharmaceuticals (ICPT), for example. I am not sure if that will happen, especially given the recent pop in ICPT, but I am confident that Gilead’s management can find a good, growth related use for all of that cash.
It seems that however you look at it, prospects for Gilead are good and still improving. Sure, the stock has been on a strong run up, but it still seems that Wall Street is behind the curve. Analysts have consistently underestimated the company, resulting in earnings beats in each of the last four quarters, and it looks like traders are underestimating it too. This isn’t some speculative stock that has unsustainable triple digit multiples; this is a company that is growing faster than even the bulls had thought possible and still has a long way to go.