If you're a value investor, your primary focus is to find stocks that are trading for less than their intrinsic value -- what the company is actually worth, all factors considered. Of course, the toughest part of that search is figuring out what that intrinsic value really is.
Gilead Sciences (NASDAQ:GILD) stock is certainly trading well below where it has in the past. Is the biotech's market cap lower than what the company should really be worth? There's a pretty good case to be made that Gilead could be a gold mine for value investors.
More art than science
In theory, figuring out Gilead's intrinsic value should be straightforward. All we have to do is calculate the net present value of the sum of all the company's future free cash flows. Theory doesn't always translate well to the real world, though.
The problem with performing this exercise for Gilead Sciences is that a whole lot of guessing is required to estimate the company's future cash flows. No one really knows, for example, how much lower Gilead's hepatitis C virus (HCV) drug sales will fall. Even the company's CEO, John Milligan, has said that he can't predict when HCV sales will stabilize.
There's also uncertainty about competition. Gilead's strong suit right now is its HIV stable of products. However, Viiv Healthcare, which is majority-owned by GlaxoSmithKline, claims two HIV drugs, Tivicay and Triumeq, that are gaining market share. The company also has several combination treatments targeting HIV in late-stage testing, which, if approved, could present a strong challenge to Gilead's dominance.
You can't assume that Gilead's pipeline candidates will eventually add to free cash flows down the road. The biotech claims several promising drugs in late-stage testing, particularly its bictegravir/F/TAF combo for HIV and autoimmune disease drug filgotinib. However, Gilead has had plenty of once-promising pipeline candidates that didn't pan out.
The biotech world in general inherently has a lot of variables that make calculating intrinsic values of biotech stocks extremely challenging. That's especially true for Gilead Sciences. The bottom line is that determining the actual worth of Gilead is a lot more art than science.
Instead of trying to dive deep into projections and calculations of Gilead's possible future free cash flows, perhaps we could work backwards to get an idea of the stock's real value. The first question to answer is this: What earnings level would Gilead need to make to trade at similar levels to other big biotechs?
The average earnings multiple among the five other biggest biotechs currently stands at just under 30. Gilead's stock trades at less than seven times trailing-12-month earnings. In 2016, Gilead's earnings totaled $13.5 billion, or roughly $10 per share. Its earnings would have to drop to below $3 billion (around $2.24 per share) for the stock to trade at the average earnings multiple of its peer group. That's a 78% plunge from Gilead's current earnings level.
Averages can be misleading, though, since an outlier can skew the result. What if we use the lowest earnings multiple of the five other biggest biotechs? Biogen's stock trades at 16 times trailing-12-month earnings. Gilead's earnings would have to fall to $5.4 billion (around $4.16 per share) for its stock to trade at the same earnings multiple as Biogen.
Can Gilead Sciences post earnings of more than $3 billion in the future? Consider that the biotech made higher earnings than that in 2013 -- before Gilead launched its first HCV drug, Sovaldi. But can Gilead earn more than $5.4 billion annually in the future?
The consensus among Wall Street analysts is that Gilead Sciences' earnings will decline by an average annual rate of 4.8% over the next five years. This projection factors in sliding HCV sales but also includes the probability of new drugs coming on the scene.
If Wall Street is right, Gilead's earnings will fall to around $8 billion by 2021. You don't have to be a mathematician to see that figure is a lot higher than what Gilead needs to earn to trade at the same level as the lowest performer in its peer group.
Here's what the Wall Street analysts aren't including in their calculations, though: the potential for Gilead Sciences to change its earnings outlook. Gilead's management has stated on multiple occasions that the goal is to make one or more acquisitions to boost growth. The company has the cash, the cash flow, and the motivation to make these deals happen.
The thing about gold mines is that the gold is already there, but people just can't see it yet. Gilead Sciences continues to have tremendous earnings power. A little good luck with its pipeline and a smart deal or two could be huge for the company. Value investors should be able to see what most others don't see yet: Gilead is a potential gold mine.