Gaby Lapera, host of the Industry Focus: Financials podcast, made it her New Year's resolution to buy at least five stocks this year, one from each sector of Industry Focus.
Illumina (NASDAQ:ILMN) and Gilead Sciences (NASDAQ:GILD) are healthcare goliaths that are disrupting their industries, and each of these companies has catalysts on deck that could reward investors in the future. Is one of these stocks a better buy for long-haul portfolios than the other?
In this episode of The Motley Fool's Industry Focus: Healthcare podcast, analysts Michael Douglass and Gaby Lapera are joined by Todd Campbell to discuss the pros and cons of these stocks, and how each of them could reward patient investors down the road.
Tune in to find out what makes both companies so appealing and what makes them such different investments; how Illumina's sequencing machines will likely change the field of healthcare at large; why Gilead is such a great long-term play even though the stock is down approximately 10% this week; and more.
A full transcript follows the video.
This podcast was recorded on Feb. 8, 2017.
Michael Douglass: Hello, everyone! Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. You're listening to the Healthcare edition, recorded today on Wednesday, February 8th, 2017. My name is Michael Douglass, subbing in for Kristine Harjes, and joining me today are Todd Campbell, Industry Focus: Healthcare's regular contributor, and special guest, Gaby Lapera. Welcome, folks!
Gaby Lapera: I just need to say something really quick. Michael, your podcast voice is very different from your real life voice, and it's really off-putting.
Douglass: Well, I'm sorry you feel that way. Todd appreciates me for who I am.
Todd Campbell: I do, I love your voice! As a matter of fact, it's been awhile since you've been on the Healthcare show, so I'm loving it even more today.
Douglass: You're very kind. As listeners might know, Gaby is joining each episode of Industry Focus this week to basically get pitched stocks. We work hard, and then she renders her decisions. So Todd and I are going to do that. But first, Gaby, I know you have some ground rules for this, so why don't we go over those?
Lapera: Yeah. This is part of my New Year's resolution, I don't know if you guys remember, I said I was going to buy stock in every sector of Industry Focus. But, the important thing to remember is that Michael and Todd are not pitching me personal ideas and advice. These are just companies that they like in their real life. I believe that Michael, in fact, owns Gilead. And when I say believe, I mean that I know, because he reminds me literally every day.
Douglass: Not every day.
Lapera: Almost every day. [laughs]
Douglass: There are days I don't remind you.
Lapera: On Sundays, because I don't see him. [laughs] So, none of this is going to be personal advice. You should not take it as personal advice for you, either. This is just, "We like these stocks, we're going to talk about them." The other things that I want to let you guys know about is that The Motley Fool has a disclosure policy. We must publicly disclose if a contributor -- so, any of us -- have an interest in any of the stocks mentioned. Additionally, Fool employees work under trading restrictions which requires that employees hold any stock they own for 10 days because we're not day traders, and also because that's just a good idea. Ideally, you're holding it for much longer than 10 days, but stuff happens. We can't write about a stock in the period of two market days before to two market days after purchasing or selling a stock, which means that I'm not going to be able to buy any of these stocks for a while, because we're also going to do another show where we talk about some other stuff. So, don't go looking at my profile and be like, "Hey, Gaby, where are the stocks?" It's going to take a little bit of time. Also, we are required to notify our compliance department anytime we buy or sell stocks, and at this is in the interest of transparency to all of our listeners/readers. We want to do that, we want to be a good company.
Douglass: Yeah. And sometimes the appearance of malfeasance is really quite bad enough on its own, so we want to make sure that there is no possible perception issue, that we are being 100% transparent and clear about this.
Lapera: Did they audit you? They audit us every once in a while. Have they audited you yet?
Douglass: No, but I'm looking forward to it.
Lapera: Our company lawyers are fearsome, and I was terrified that I had forgotten to do every single step the last time I got audited.
Douglass: But everything turned out well.
Lapera: Everything was fine. It's random audits, they weren't suspicious of me.
Douglass: That's good. Let's hop in. We're talking about two socks today. Todd's going to be pitching Illumina, I'm going to be pitching Gilead. These stocks are basically two vastly different stories, but I'm sure we'll get more into that in a minute. Todd, why don't you go ahead and start us off?
Campbell: First of all, Gaby, I think this is a phenomenal idea for a show. And it's perfectly timed. It's almost like the Super Bowl of stocks. Too soon for the non-Patriot fans among you?
Douglass: Gaby is saying "uh" because, Gilead reported earnings yesterday, and I have been counting down toward it, sort of like some people count down toward the Super Bowl. Several colleagues internally, including Gaby, have been rolling their eyes at me. Anyway, that's neither here nor there. Illumina, go ahead.
Campbell: [laughs] All right. Gaby, I didn't do this for you, this is not specific advice for you. But, with hundreds of stocks to choose from, I had to set some sort of ground rules for myself, and coming up with an idea that I wanted to talk about today. So, what I did is I created in my head a hypothetical investor. And that hypothetical investor is someone who is maybe in their twenties, thirties, early forties. They have a 10-30 year time horizon for investing in the market. They're doing everything they should be doing as far as putting aside their income, 10% or more every year. And they want to also own individual stocks in a diversified portfolio that includes healthcare. So, that was step one: what would fit that hypothetical investor well?
The the second thing was, if I'm going to narrow down the list further, what is it about some of the greatest, best-returning, most revolutionary companies of the last 10 to 20 years? What common thread do they have? That would include stocks like Amazon, Google, Netflix, Priceline, truly disruptive companies that reshaped industries and quickly became leaders within their field. And that one common thread that they all share is that they put innovation first. They're innovation first companies. Their goal is, consistently, disrupt, disrupt, disrupt. They are far less worried about what happens in one quarter to the next quarter to the next. They are looking long term, they're playing the long game.
So, when I thought about healthcare with that backdrop, the name that jumped to the forefront was Illumina. And I'll talk about why in a second, but I thought it might be fun first to play a quick game.
Lapera: OK, I'm ready.
Campbell: OK. Michael, are you ready?
Campbell: Over or under -- are there over or under 50 million Baby Boomers in America?
Campbell: Yes. 76 million Baby Boomers. And guess what -- they're all living longer lives. So, we have this huge aging patient population in America. Next one, over or under -- there are over or under five billion people in the world?
Campbell: 7.5 billion people living in the world today. And there were 15 million people being born so far this year alone. So, in the first month and a couple weeks, 15 million new births. What do you think the global life expectancy is going to do, for all of these people over the course of the next 10-30 years? Is it going to get shorter, or is it going to get longer?
Lapera: Longer. Probably.
Campbell: Absolutely. So, we have this huge patient population that is growing and living longer. And that's going to create a tremendous amount of demand across the healthcare industry. That's one of the reasons that I feel that healthcare stocks should be part of a diversified portfolio. So now, let's get into why I like Illumina. I mentioned that I liked innovation-first companies. Well, Illumina is now being run by a guy named Francis deSouza. And Francis, in his most recent conference call with investors, said, "At our core, and this has been true since the founding of the company, we are an innovation-driven company and we spend a lot of time thinking about the fundamental breakthroughs that will accelerate the adoption of genomics, and accelerate, as in our mission to improve, human health through unlocking the power of the genome." And the way that he and this company are going to do that is by developing increasingly more powerful genetic sequencing machines. They are going to allow researchers and drug developers to dive deeper and deeper and deeper into the understanding of how our bodies work. And in doing that, they're going to be able to unlock discoveries that will lead to new medicines that more accurately can treat individuals, and that can transform outcomes. And that is at the crux of why I like Illumina as a long-term investment. They are the Goliath, the Amazon, of their industry în making genetic sequencing machines. They have more than 7,500 of these machines deployed throughout the world. And they just rolled out new machines this year -- the NovaSeq 5000 and NovaSeq 6000. These machines are faster, they're better, and they're likely to spark a major overhaul of all of those thousands of machines that are already deployed throughout the world. I think that could kick-start a significant amount of demand, and unleash a lot of genetic research that otherwise has not been conducted today because of its expense.
And the reason behind that -- I'm getting long-winded -- is that these machines put in place a pathway to reduce the cost of sequencing a genome from $1,000 today to eventually as little as $100. To put that in perspective, in 2010, it cost $10,000 to sequence genomes. So, as this price falls, we're likely to see far more research getting done, and that's likely to drive demand for the consumables that are used by these machines.
Douglass: All right.
Lapera: I have so many questions for that, but we're going to reserve the Q&A until later.
Douglass: All right. Very good. Thank you, Todd. Let me give a brief pitch for Gilead Sciences. 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 to 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.
All right. The Q&A. Gaby, fire away!
Lapera: OK. My first question is actually for Todd, because I am very interested in genomics. I might ask you some questions that throw you for a loop, because I don't know if you know this about me, talking about books that we read in our spare time, I really enjoy genetics a lot. [laughs] So, my first question for you is, do you know anything about epigenetics? Let's start there.
Campbell: I know it's a major area of research, and a lot of money has been put forth in research into it. Celgene has some stakes, and a couple different companies are doing some work on it, but I haven't taken a look at it recently.
Lapera: OK. That was actually going to be my first question. Epigenetics is kind of ... we should do a show on epigenetics, Michael. We'll forget Kristine. [laughs]
Campbell: We'll ask Kristine what she would like to do, and you two can sort that out. I am filling in today.
Lapera: But, I'm really interested to know, does Illumina have any plans to do anything with epigenetics? Because epigenetics also requires a type of sequencing, and it's becoming more and more important, especially as we realize the effect that epigenetics has on disease outcomes for individuals. Is there any future for that? Or is this just me wildly speculating?
Campbell: Here's the thing -- the whole concept is to figure out how we can sequence not only the body, but also sequence tumor cells, to learn more about tumors so that we can better attack them. So, there's a tremendous amount of research that's going on through drug companies throughout the world to try and evaluate the DNA and RNA that is responsible for disease. And not just genetic disease like Down syndrome or something like that. It's also cancer. And I think you're going to see more, not less, of that activity going on. I mean, you have China spending $9 billion on its own precision medicine initiative. You have the U.S. spending billions of dollars on ours. Europe is doing programs like this as well. And the whole idea behind it is to learn more about our bodies and disease so that we can better target therapies to it. And it doesn't matter where, if it has to do with genetics, they're going to be using machines like Illumina's. And Illumina is the biggest player. It's like the Coca-Cola (NYSE: KO) of this industry. So, my feeling is, if you believe that epigenetics is the future, and research is going to be done on genes and these gene discoveries are going to be delivered by machines like this, then Illumina is a stock to buy.
Lapera: OK. Now I have a few more questions based on my time spent in labs. What's the life cycle intended for these products? Because I have totally worked in labs where they are using the same machinery that they have had since '95, like, you need a Windows 95 compatible computer to run these machines. Is that going to be a problem?
Campbell: These are all next generation stuff. The life cycle is measured in years, not decades. The last major launch was about five or six years ago, the HiSeq X Ten. When that came out, that's what dropped the cost of sequencing the genome from $10,000 to about $1,000. Obviously, the NovaSeq that's coming out this year is probably going to have a five to eight year lenght, something like that. The transition to these machines won't happen overnight. It'll be a slow, as you would imagine, roll out. As people bring these machines in, they get comfortable, and they shut down the use of the older machines. But, I think that creates an opportunity where, if revenue slows a little bit this year, then it could reaccelerate as we get into '18, '19, and '20, as more and more of these machines get swapped out for these machines, and researchers to get more comfortable using them.
Lapera: Yeah. That's interesting. Most of my experience with research has been in grant-funded labs, as opposed to commercial labs. So, there, it's a matter of, do we have the money to buy a new machine? No? Then we're sticking with the one that's 25 years old.
Campbell: Yeah, and I think that what you're going to find is, there are more and more ways to be able to leverage of the technology and the discoveries by those researchers using these grants. That's one of the reasons, too, that so much money is being contributed now by the NIH and grants to things like the precision medicine initiative to do gene sequencing, specifically calling out, this is a major area for funding.
Lapera: Cool. Thank you very much. Do you have any questions for Todd about Illumina?
Douglass: No, I don't think I do.
Lapera: OK, well, I am ready to ask you some questions about Gilead.
Lapera: We know that Gilead is in the HIV and hepatitis C space. What would they be looking to expand into? Would they continue into HIV, or ... ?
Douglass: Great question. Company management is always a little hesitant about tipping their hand too much. But, what Gilead's management and has shared is that they are looking to expand into cancer and into autoimmune diseases. A great example of this was, Gilead basically purchased the rights to a drug called filgotinib from a biotech called Galapagos last year. And filgotinib is an autoimmune disease drug potentially, and they got it for a good price. And it looks like, if the clinical trials continue to show positive data, and if it grows into the marketing expectations, the peak sales expectations that analysts have guided for, that it could be worth quite a bit more than they paid for it. So, that's just classically Gilead, to find something that people think they know the opportunity with and find a greater opportunity with it. So, yeah, it looks like they're thinking more along the autoimmune and cancer lines. That said, they actually have a couple of cardiovascular drugs, which they basically purchased because they were off the shelf ready to go. So, it didn't require a lot of investment by them to make it happen. Management has also said that they would be willing to get some off the shelf stuff that's outside their core areas of competence, if you pay up front and it just goes. So, I think we could see either way. But I think it's more likely that we'll see more autoimmune and cancer.
Lapera: Interesting. Does Gilead do mainly purchases, and then a little bit of in-house tinkering? Or does it have a really big in-house R&D department as well?
Douglass: They do have a big in-house R&D department, and a lot of their drugs are internally sourced. That said, they do a pretty good job of also finding external drugs. I would characterize management's philosophy as, "Wherever we can get the best ROI on our time and money, we will do it." So, they've done a good job on both ends.
Lapera: This is my out-there question for you: do you think Gilead will kill hepatitis C? Well, Gilead and all the other drug companies that have hep C drugs.
Douglass: To be clear, there are a couple of other competitors, primarily Merck and AbbVie. They have relatively low market share, we're talking about, when last shared, Gilead's market share was in the mid 80s. So, they're the big dog in the space. I think it's going to be a very long time before hepatitis C is completely gone. And that's because it's relatively easy, comparatively easy, for somebody to get hepatitis C treatment here in the United States or in Europe. It's going to be a lot harder in Nigeria or somewhere else where there isn't an enormous healthcare system. I do believe that hepatitis C can be pretty close to wiped out, but it's not going to be a next year, or even -- I think, and I'm totally speculating here -- next decade kind of thing.
Lapera: That's totally fair. I mean, we technically still have leprosy. And by technically, I mean we definitely do. Don't pick up armadillos, they are the primary vector of infection in the United States for leprosy. Fun fact! I'm well known around The Fool for my not-so-fun facts, unfortunately. [laughs]
Douglass: They are always something. [laughs]
Lapera: Todd, do you have any questions for Michael?
Campbell: Oh, so many questions, but I know we're a little bit tight on time. And I know that Michael probably has some questions about Illumina, too, and he's just being kind. I would just say to all of our listeners, we have tons of content on this on The Fool website, so if they have any questions that they're not getting answered by us, please go there. I think Michael did a great job in explaining the backstory and the reason to buy this one.
Lapera: Everyone has been so polite, it's incredible. I thought you all would be really cutthroat, and everyone's like, "No, it's wonderful!"
Douglass: Well, Todd and I are old friends, we've worked together for a while now. And Todd, I'll also say, I thought that was a very good high level on healthcare and Illumina's opportunity. Folks, if you do have a specific question and you want an answer, shoot us an email at email@example.com. I guarantee we will respond. We love listener emails. In fact, a couple weeks ago, Dylan Lewis brought be back for an encore episode because a listener emailed in and had a question, and we were like, "Cool, we'll do a whole episode based on that." Now, I'm not guaranteeing an episode here, but we will get you an answer. We're passionate about stocks, it's just kind of what we do. So, that's big for us.
Lapera: Yeah. I actually do have one more question for both of you, which I've asked everyone else so far. If you could give one piece of advice to a beginning investor, what would it be?
Douglass: For me, the big one would be, when you're new to a sector, go big. By that, what I mean is, healthcare, energy, a lot of these sectors are really kind of difficult to get your feet wet in, and it's great to start with a big cat company. Do not go for some $200 million clinical stage biotech before you really understand the overall disease treatment sphere. Big companies are really great for that. They tend to be well diversified, they tend to have a lot of different products. So, you can get a sense of a bunch of different markets. Plus, if you're wrong in your investing thesis, chances are good the company's not going to go out of business. When you pick the really small ones, they could just die, whereas a J&J, a CVS, a Gilead or an Illumina, probably going to be around a few years from now, barring something really crazy happening.
Campbell: Diversify. Diversify, diversify, diversify. Kristine and I talk about this every week on the show, especially when you're dealing with healthcare and biotechnology stocks, biopharma, make sure that you don't put all those eggs in one basket. Spread it around a little bit, because there are things that cause stumbles and 10% drops in one day, and you need to be able to ride that out across an entire portfolio.
Lapera: Thank you. Those are two very good pieces of advice, and I think we have had a very thoughtful and substantial conversation, as I've had the last two days.
Douglass: Well, good, fantastic. Well, Gaby, thanks for joining us on Industry Focus: Healthcare. I'm also glad to have gotten to hop in for a bit, and Todd, as always, thanks for everything you're doing. As always, remember, contributors on the show may own stocks we discuss, and The Motley Fool may have recommendations for or against stocks that we're discussing, so please do not buy or sell or really do anything with a stock based solely on what you hear. Always do your own due diligence. It's the right way, it's the Foolish way. For Todd Campbell and Gaby Lapera, I'm Michael Douglass, thanks much and Fool on!