Buy Gilead Sciences for a 42% Profit? What You Need to Know

Berenberg sees life after hepatitis C.

Rich Smith
Rich Smith
Sep 12, 2016 at 1:40PM
Health Care

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.


Hepatitis is a scary word -- but frighteningly profitable for Gilead Sciences. Image source: Getty Images.

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.