Why Gilead Sciences Is a Buy

Gilead Sciences (GILD 0.07%) is the leading maker of drugs used to treat HIV and hepatitis C, but sales and profits are slipping as fewer hepatitis C patients begin treatment and competition drives down drug prices. Can Gilead Sciences overcome these headwinds and reward investors with gains?

In this clip from The Motley Fool's Industry Focus: Healthcare podcast, analyst Michael Douglass explains why he thinks this stock is a buy.

A full transcript follows the video.

This podcast was recorded on Feb. 8, 2017.

Michael Douglass: Gilead Sciences is a stock that is primarily in two businesses today: treating HIV and curing hepatitis C. It is the market share leader in both. So, it's kind of the big dog in both of these enormous markets. Now, usually, it's kind of hard for people to recommend a stock that is down 10% the day that they're recommending it, after guiding for its 2017 to fall by over 20% at the midpoint from its 2016 numbers. But I think that Gilead Sciences has an underappreciated and enormous opportunity. So, let's talk about it.

Hepatitis C, they are curing patients. Unlike with HIV, where, once you have HIV, you pretty much have it for life, and there are treatments designed to manage the disease, with hepatitis C, these are cures. We're talking 95%-99% cure rates for hepatitis C. So, when it onboards a patient, it cures that patient, and that patient falls out of the revenue cycle for Gilead because they no longer have hepatitis C. So, hepatitis C revenue is on the decline, and that's because they have basically treated the sickest patients, so they are now increasingly treating less-sick patients who need less medicine to get better, to be cured, and who are also less urgently in need, so they are seeking treatment at a slower rate. So, that is going to drag on the company's top line, for sure, and that's why they are guiding for the revenue to fall so much next year. HIV is supposed to be stable to maybe a little bit up.

Now, I think the key part of the thesis for Gilead is optionality. That stems from two things. First off, they have a superb management, with a fantastic history of accretive acquisitions, and I'll talk briefly about a couple of them. When they bought Triangle Pharmaceuticals in 2003 and Pharmasset in 2012, in both cases, there was a lot of speculation by analysts that they overpaid. Triangle provided an HIV drug called emtricitabine, which is a big part of Gilead's HIV franchise. Pharmasset provided sofosbuvir, which is a big part of Gilead's hepatitis C franchise. In both cases, they made several multiples of what those acquisitions cost them pretty quickly. Gilead has a management that is really good at allocating capital. And that, I think, is one of the key differentiators in healthcare and any industry -- if you have a management who really knows what they're doing, they can make really good things happen.

The second piece of optionality that Gilead has is, it has a ton of cash. The hepatitis C franchise might be on the decline, but it is a cash cow. We're talking 88%-90% gross margins on their drugs, so there's a lot of cash that they have sitting, about $32 billion. And management has said that their primary focus in 2017, I'm quoting CFO Robin Washington here, "Leveraging our capital to pursue external opportunities to expand our R&D pipeline." What that means is M&A. Now, Gilead, with all that cash, can buy a lot in healthcare. There are a lot of healthcare companies that it could do a tie-up with. So, what'll be interesting, of course, is whether they maintain that discipline. The fact that they have maintained that discipline, even though they are guiding for their revenue to decline this next year, and even though Wall Street has been pushing them to buy somebody already for over a year, really speaks, I think, to management's confidence in its own ability. The second thing is, frankly, with that $32 billion in cash, their market cap is in the upper $80 billions, they could, right now, retire over a third of their shares outstanding at current prices, because they're trading at about 6.5X earnings. So, where Illumina is very much a growth play, I think Gilead is very much a valuation play, and I think it is an incredibly attractive company at these prices, even with the declines built in for next year. And especially given what it can do with that cash, and with the superb management team.