Shares of Gilead Sciences (NASDAQ:GILD) stock are on a tear -- in the wrong direction.
Down 29% over the past year, and down 20% since 2016 began, Gilead appears to be one of the least popular, $100 billion biopharmaceutical giants on the planet today. And yet, this morning it gained a fan.
Bright and early Monday morning, analysts at German investment banker Berenberg announced they are initiating coverage of Gilead stock with a buy rating and a $112 price target. If the analyst is right about that price, new buyers of Gilead stock have an opportunity to cash in on a 42% profit opportunity (Gilead shares cost less than $79 today). But is Berenberg right? Let's find out.
Here are three things you need to know.
1. They "grew from nothing"
Berenberg is most impressed with how Gilead built its hepatitis C treatment business from "nothing" in 2012 into a $19 billion sales behemoth today. As described in a write-up on StreetInsider.com today, sales of Gilead's hep C drugs such as Sovaldi and Harvoni helped Gilead Sciences "triple" its revenue over the past three years.
S&P Global Market Intelligence data, which do not break out revenue by product, nonetheless confirm Berenberg's broader assessment. In 2013, Gilead booked $11.2 billion in revenue. Last year, those sales had grown to $32.6 billion.
2. But growth has stalled
And yet, the news is not all good. By this point, says Berenberg, "many of the sickest patients have now been treated" with Gilead's drugs. The $19 billion in hep C sales recorded last year, warns the analyst, "represents peak sales," and those sales are now likely to decline.
In fact, they have already begun to decline, and "faster-than-expected." Moreover, Berenberg is pretty sure that the decline in sales will be "steeper" than most analysts currently expect. By 2019, the analyst forecasts that Gilead's hep C business will be bringing in barely $10 billion by 2019 -- a decline of nearly half.
3. And that's OK
Such a prediction appears to set the stage for further disappointment, and additional downgrades of Gilead Sciences stock. So why is Berenberg initiating coverage of the stock with a buy rating?
Basically, the answer comes in two parts. While sales will decline, "a large pool" of treatable patients still remains to be reached.
What's more, even if $10 billion in sales three years from now is less business than Gilead does today, it's still a lot of revenue -- and as Berenberg points out, it's also very high-margin revenue. According to the analyst, Gilead gets "margins over 90%" on its hep C drugs, enough to help the company earn pre-tax profits of roughly $49 billion "between 2016 and 2020." That's nearly half the company's current market cap that can potentially be earned back over just the next four years.
The most important thing: Valuation
So what does all of this mean for investors in Gilead stock?
Currently valued at $103.6 billion in market capitalization, and $116.4 billion in enterprise value (factoring in net debt), Gilead Sciences stock costs just 6.9 times earnings, and has a debt-adjusted price-to-earnings ratio of only 7.1.
Earnings quality is also extremely strong. With $17 billion in free cash flow more than matching reported earnings of $16.3 billion for the past 12 months, the company's enterprise-value-to-free-cash-flow ratio is a mere 6.8.
While it's true that the stock is not expected to grow profits much, it is expected to grow some, even with the decline of the hepatitis C business factored in -- about 3% annualized over the next five years. Ordinarily, I don't invest in growers this slow myself, but when combined with a respectable 2.4% dividend yield, I have to say:
I think Berenberg is right about this one. There's still a lot of value to be found in shares this cheap.
Fool contributor Rich Smith does not own shares of, nor is he short, any company named above. You can find him on Motley Fool CAPS, publicly pontificating under the handle TMFDitty, where he currently ranks No. 286 out of more than 75,000 rated members.
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