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Is The Worst Behind Gilead Sciences?

By Motley Fool Staff – May 24, 2017 at 8:34AM

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Falling hepatitis C sales are dragging sales and profit lower. Here's what could happen next.

Sliding hepatitis C sales have made Gilead Sciences (GILD 3.82%) shares one of the market's worst performers since 2015. However, its HIV drug sales are growing, and Gilead Sciences has tens of billions of dollars in cash it can use to kick-start growth through mergers and acquisitions. Is this company showing signs that it's about to turn a corner?

In this clip from The Motley Fool's Industry Focus: Healthcare podcast, analyst Kristine Harjes is joined by Todd Campbell to discuss Gilead Sciences performance this year, its product pipeline, and the obstacles it has to overcome to see its shares head higher again.

A full transcript follows the video.

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This video was recorded on May 17, 2017.

Kristine Harjes: We said we were going to talk about Gilead Sciences, and that was not a lie. It is now time to dive into Gilead.

Todd Campbell: This one hits a little bit close to home for me, Kristine, and I think maybe it does for you, too?

Harjes: As a shareholder? Yeah.

Campbell: Yeah. This is a stock that is a behemoth in biotech. And unfortunately, its shares have fallen from $120 to about $65 since the summer of 2015, making the comparison even worse when you look at the fact that the S&P 500 has rallied and has been flirting with new highs. This stock has gotten clobbered. And it's been a tough run for shareholders like me, and I have to -- can we do a little confessional here?

Harjes: Let's hear it.

Campbell: I confess, I made a grave error in the way I normally approach stocks. I usually buy stocks -- we talked about this last week -- based on a particular catalyst, and then when I'm evaluating whether or not to hold the stock, I see if anything's changed that catalyst. Now, normally, if the catalyst has failed to pan out or change, that's a signal to me that I should sell or exit the stock. My catalyst did, indeed, change for Gilead, and I did not sell the stock. My cost is somewhere in the $90s, I'm down 20%-25%.

Harjes: What was the catalyst that you were looking for?

Campbell: I really thought their leadership in developing hepatitis C drugs was going to allow them to continue to innovate and dominate the market, which they have. But I also felt they would be able to innovate shorter and shorter treatment duration, getting it down to as little as four weeks over time from the 12 weeks it is currently. And it does look like that's not in the cards. It looks like they're slowing down their efforts to continue to move the needle in developing new products for hepatitis C. I also underestimated the negative drag and impact of price concessions they would be forced to make to stay ahead of competitors like AbbVie. And, I also had bought it originally because I had some good thoughts that they would do well with their push into cancer drugs, and unfortunately that was a bust. Yet I looked at it and said, this is still a very profitable company, and now they're paying a dividend, and they have a ton of cash on the balance sheet, so I guess I'll stick around. Obviously, so far, that's been the wrong choice.

Harjes: The thing is, you talked a lot about hepatitis C, and I think that is what most people focus on with this company. But if you look at what has happened to the company over the course of its HCV life cycle, its first hepatitis C drug, Sovaldi, was approved in December 2013. At the time of approval, Gilead's market cap was $114 billion. Today's market cap of $86 billion is 25% lower than that. For me, I look at this company and I just can't help but think that the market has overreacted to its hepatitis C woes. And you're totally right about cancer not quite panning out, but I don't think there is as high hope and drama and expectation tied into its oncology efforts, necessarily, as it was for HCV sales.

Campbell: Yeah. I agree with you, in some respects. But here's the problem: We have yet to find a floor on those hepatitis C sales. In Q1, revenue came in a $2.6 billion across their hepatitis C franchise. That was down from $4.3 billion the year before.

Harjes: Yeah, that's a 40% decline.

Campbell: Yeah, massive drag. As a result, Q1 total sales were $6.5 billion. That was down 16.5%. EPS fell from $3.03 last year to $2.23 this year, ouch.

Harjes: Yeah, and I totally agree that that does hurt. But I think with this company, it's important to remember that they have other things going on. In particular, their HIV products were very good in the last quarter. And that was how this company really made its name. Its HIV and HBV product sales were up year over year in the first quarter 13% to $3.3 billion. That's a good thing. Sales fell for some of the older products, but it was made up for by the newer ones like Genvoya and Descovy and Odefsey.

Campbell: Right. They've enjoyed a lot of growth, and that's because they reformulated Viread. They made it safer, and now they've been rolling out combination therapies that replace Viread in those combinations with TAF, this new formulation. I imagine that we'll probably see a leveling off in sales growth there once all the combination therapies have been launched. But yes, they remain a dynamo in that business. It's a great business for them, and it's been a growing business for them; it just hasn't been growing fast enough to offset the slide in sales in hepatitis C. So, you look at it from an investment standpoint now, and you say, OK, well, we know that HIV is going to be stable to growing. That's good. And we know that hepatitis C is declining, and we don't know where the floor is.

Harjes: And that's bad.

Campbell: Yeah, that's bad. So, we say, what's the catalyst, what's going to cause this stock to get back to growth? Because, ultimately, we want to see sales grow, earnings grow. Shares will follow earnings over time. So we look at it and say, they have, first of all, a lot of money on the balance sheet, isn't it something like $32 billion?

Harjes: I have this right here -- $14.7 billion in cash. That's without their short-term investments.

Campbell: Yeah, and securities that they can sell as well. And they spend a ton on research and development. I think their run rate now on research and development is something like $3.6 billion. So they have a pipeline and they're working on that pipeline. So you say, maybe new drugs coming out of that pipeline, or acquisitions, because of all this cash, can spark growth, right?

Harjes: Yeah. So you have the organic side and you have the inorganic side. And when you look at the organic side, what are they actually developing themselves, they do have some exciting things going on. But it's going to be a while before we hear about any of them. And so that's when you get this pressure for the inorganic growth. And there has been so much speculation about who is Gilead going to buy, when are they finally going to pull the trigger? I do think, at least in the short term, that's the catalyst to watch. What are they going to do with that money? Who are they going to buy? When will they actually make a move to try to bolster their portfolio and get some more internal catalysts to get revenue moving in the right direction before, say, 2020, when they start getting data for all of the really awesome drugs in their pipeline that are not quite ready for market yet.

Campbell: Yeah. If you look at the lead candidates in the pipeline, you have filgotinib, which is the autoimmune-disease drug they're working with Galapagos on. Data for that should start rolling in, I think, as early as next year, stretching through 2020, depending on the indication and the trial we're talking about. Then there's another one for something called NASH, which is another liver disease, but, again, we won't see data from that until the 2020s as well. So you look at that and say, OK, there's not a whole heck of a lot that's going to, as far as drugs that are going to hit the market that could really make a big deal here. So what would be the M&A target? Can they buy something? Then, assuming they can cut a lot of overlapping expenses, maybe they can get operating margin moving in the right direction again. But only time will tell. We have to see how that plays out. And Gilead is being patient. They have the war chest, and they have the money, but they look at it from an operational standpoint, saying, "I don't want to pay too much for this company when, three years from now, I could get it for a bargain."

Harjes: Well, that, and they look at their own company and they say, "Holy moley, this is cheap." Gilead spent $14.8 billion on shareholder rewards in the last 16 months; $12 billion of that was on share repurchases. So this company is not interested in buying other overpriced assets when it could just buy back its own stock at pretty low valuations.

Campbell: Yeah. Although you take the other end of that coin and say, from a shareholder standpoint, is that the best use of your dollars? So far it has not been, because shares have still declined. So you brought back a lot of shares at a lot higher prices. Has that been the best use of your money, where if you had gone out and bought something like Medivation or something, to kick-start growth that way, would that have been a better reward for shareholders? Who knows? We don't know. The reality is, this remains a biotech behemoth. They're not going away. At some point, somewhere down the line, they're going to do something that will restart growth. The question will be, where will shares be at that point? Is this the low? Was $80 the low? Was $90 the low? I don't know.

Harjes: Right. And when they do it, we will absolutely have you covered here on Industry Focus

Kristine Harjes owns shares of Gilead Sciences. Todd Campbell owns shares of Gilead Sciences. The Motley Fool owns shares of and recommends Gilead Sciences. The Motley Fool has the following options: short June 2017 $70 calls on Gilead Sciences. The Motley Fool has a disclosure policy.

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