Gilead Sciences (NASDAQ: GILD) has had a tough time over the last several years, with its shares falling over 40% since 2015. This price performance has been driven by a collapse in earnings, with earnings per share (EPS) falling close to 70% from 2015 to 2018.
A value investor may find Gilead intriguing at its current price-to-earnings (P/E) ratio of a little over 14, a significant discount to the market multiple. However, the same value investor would have found it even more compelling at nine times earnings four years ago and incurred significant investment losses as a result. Will history repeat itself or is Gilead attractive at current levels? Put another way, is Gilead a value stock or a value trap?
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Gilead's hepatitis C problem has a cure
To answer this question, we should first review Gilead's earnings history. Gilead's sales and net income peaked in 2015, at $32.6 billion and $18.1 billion, respectively. In the ensuing three years, sales dropped by 32% and net income fell by close to 70% -- a staggering decline. This is in stark contrast to the three-year period from 2012 to 2015, when net income rose sevenfold.
The factors behind the explosive growth in earnings on the one hand and the ensuing collapse on the other are really one and the same -- Gilead's hepatitis C virus (HCV) franchise. Gilead has dominated the market for hepatitis C since its acquisition of Pharmasset in 2011. Ironically, Gilead's problem is that it has been too successful -- its products cure patients, leading to an ever-shrinking market.
After peaking at $19 billion in sales in 2015, Gilead's HCV revenue fell to $3.7 billion in 2018. However, the market for HCV drugs will never disappear altogether as new patients emerge. And with revenue down to only 15% of the peak, Gilead's HCV franchise should be less of a drag on earnings going forward. Indeed, in the most recent Q3 earnings report, although HCV product sales fell 25% from prior-year levels, the revenue impact was relatively muted at a little over $200 million compared to overall product sales of $5.5 billion.
Meanwhile, Gilead has been active in trying to diversify away from HCV. It continues to focus on its HIV franchise, where revenue in fiscal 2018 grew 25% to $14.6 billion over the prior two years with six drugs generating over $1 billion in sales. This trend has continued into 2019, with Q3 HIV sales rising 13% year over year.
Gilead has also made significant progress in developing a pipeline outside of HIV and HCV in areas such as oncology and immunology. Overall, the research and development pipeline includes 119 active clinical studies, of which 41 are phase 3 clinical trials.
Gilead isn't just focused on organic growth. It's also open to acquiring growth externally, and its track record for doing so has been exemplary. The company's acquisition of Pharmasset in 2011 is among the most successful in history, as Gilead spent $11 billion on a company that generated over $58 billion in sales and $25 billion in profits over five years.
In 2017, Gilead spent another $11 billion for Kite Pharma for access to a new type of cancer therapy. Although it's too early to judge the success of this transaction, given Gilead's long history of successful acquisitions (others include NeXstar Pharmaceuticals, Corus Pharma, Myogen, CV Therapeutics, to name a few), we should give them the benefit of the doubt.
The numbers add up
Not only does Gilead have the expertise to conduct large scale acquisitions, but it also has the financial wherewithal to do so. Although long-term debt has increased in recent years, Gilead still has net cash on its balance sheet, courtesy of the $31 billion it has in cash and marketable securities.
Its free cash flow generation is more than double the dividends it pays out. And those dividends are nothing to laugh about. At a yield of over 4%, Gilead is among the highest-yielding biotech companies with the potential for further growth. Gilead has grown its dividend every year since initiating its dividend in 2015 with total growth exceeding 40%.
After declining for four consecutive years, Gilead's revenues recorded a slight uptick in the most recent 12 months. The company's recent Q3 results further confirmed this trend with total revenue up year over year. Although it's too early to tell whether this is a true turning point, the odds are that Gilead's problems are behind it and a course is being set for sustainable growth.
With shares trading at a discount to the overall market and a strong 4% dividend yield, Gilead looks less like a value trap and more like a good value.
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