If This Biotech Drops Much Further I'm Going to Buy It!

We've seen a little bit of a relief rally over the past couple of days in the overall market with the start of earnings season giving investors hope that the U.S. economy and corporations can keep motoring higher.

On the all, though, it's been a rough go for the biotech sector which has been absolutely clobbered over the past seven weeks. In total, the SPDR S&P Biotech ETF is down 26% since it hit its closing high on Feb. 27.

Source: Steven Depolo, Flickr.

As I've postulated over the past couple weeks a number of factors have played into the recent biotech swoon, including frothy post-IPO valuations, and richly valued companies which have non-diversified or entirely clinical-stage pipelines. We all know that biotech valuations couldn't go up forever and I've pointed out quite a few questionable valuations in my weekly "3 Stocks Near 52-Week Highs Worth Selling" column that fit the bill from the biotech sector.

However, this recent sell-off has also created a very select number of buying opportunities for some high-quality biotech companies. One, in particular, has a valuation so intriguing that if it drops much further I'm going to buy it.

This biopharmaceutical juggernaut is none other than Gilead Sciences (GILD -1.17%).

Three reasons Gilead shares are down
Let me be clear, Gilead Sciences shareholders have already had quite the run higher. Shares could have been purchased for less than $20 per share (split-adjusted) in late 2011 and are now trading for more than triple that as of yesterday's close, so it's not as if Gilead hasn't participated in the multi-year biotech run.

But, Gilead shareholders have nonetheless found themselves under pressure for a trio of reasons.

The first issue is simply guilt-by-association. Investor confidence in the biotech sector is clearly shaken, and with a market value north of $100 billion Gilead has been something of a whipping post for short-sellers and skeptical investors. If volatility increases Gilead's shares could continue to vacillate wildly.

Secondly, Gilead has taken heat for the pricing of its newly approved oral hepatitis C therapy known as Sovaldi. Sovaldi is nothing short of a breakthrough in patient care for Hepatitis C patients in that it delivered a sustained virologic response (SVR) of 90% or greater in multiple genotype 1 through 4 studies, and it can be taken by genotype 2 & 3 patients without the need for interferon. This is important because interferon is known to cause flu-like symptoms in patients throughout the course of treatment, marking Sovaldi as a dramatic improvement in patient quality of life. Unfortunately, Sovaldi prices out at $84,000 for a full course of treatment, which has drawn the ire of Congress who deemed the therapy as overpriced and well beyond the budgets of infected patients.

Source: Centers for Disease Control and Prevention.

Finally, the treatment landscape surrounding Hepatitis C, which looked like a sure win for Gilead, is starting to get more crowded. Investors were well aware of AbbVie's (ABBV 0.28%) hepatitis C direct-acting antiviral combo which has demonstrated SVR's of 90% or greater in a number of late-stage trials. Just days ago AbbVie announced results from its TURQUOISE-II trials where a number of genotype 1 cohorts actually experienced 100% SVR. 

But, there are a number of new additions to the hepatitis C race that were unexpected. Bristol-Myers Squibb (BMY 0.98%), for instance, reported a week ago that the combination of daclatasivir and asunaprevir over a 24-week treatment period delivered an SVR of 90% in genotype 1b patients and an 82% SVR in patients that had failed to respond to prior therapy.

Merck (MRK -0.13%), continuing the parade of positive hepatitis C data, reported last week that its combination therapy of MK-5172 and MK-8742 delivered an SVR of 98% in a mid-stage study over 12 weeks with a 94% cure rate with the additional use of a ribavirin.

In other words, Gilead's got quite a bit of competition lined up to potentially take on Sovaldi.

Reasons I'd consider buying Gilead
In spite of these concerns, I also have a number of reasons to believe that Gilead shares have a bright future ahead.

To address the concerns of competition I'd contend that the hepatitis C market is more than big enough to accommodate two, or even three, blockbuster therapies. Based on estimates from the Centers for Disease Control and Prevention there are about 3.2 million people in the U.S. with hepatitis C, but a good portion of the infected are unaware they have the disease. With Obamacare requiring individuals to purchase health insurance it could encourage more people to visit the doctor and lead to more preventative testing, including hepatitis C testing. Overall, this would be good for the entire sector.

But we have to look at this from the bigger picture. According to estimates from the World Health Organization there are 180 million people worldwide with hepatitis C, leaving a wide moat for these biopharmaceuticals to target. As Sovaldi expands overseas, even at potentially lower price points, there's a good chance Gilead will see huge benefits.

On top of its wide moat opportunity, I'd contend that Sovaldi may hold the convenience edge of any possible hepatitis C therapy currently in clinical testing. Currently under priority review by the FDA, the combination of ledipasvir and Sovaldi in genotype 1 patients led to an SVR of between 93% and 99% in three phase 3 studies. Specifically, two cohorts (one treatment-naïve group that received the combo plus a ribavirin and one cohort of cirrhotic patients that received just the combo therapy) achieved SVRs of 93%-94% in just eight weeks! This incredibly fast efficacy could give Sovaldi the edge with select genotype 1 patients.

We also need to remember that Gilead is about more than just Sovaldi. Gilead also has Stribild, its revolutionary oral four-in-one HIV-1 medication designed to slow disease progression. Gilead's previous HIV-1 therapy, Atripla, is a formulation comprised of three separate compounds from three different companies that resulted in revenue sharing. Gilead's new therapy is made entirely in-house allowing Gilead to pocket all sales for itself.

Gilead's pipeline is nothing to sneeze at, either. Inclusive of U.S. therapies that are currently submitted to the FDA for review or under review, Gilead has 32 ongoing experimental studies. These ongoing studies include its exciting leukemia drug idelalisib which could very easily have blockbuster potential if approved. Best of all, this comes on top of 16 FDA-approved therapies which helped push Gilead to $10.8 billion in revenue for fiscal 2013, up 15% from the previous year.

From a valuation perspective Gilead is projected by Wall Street to earn more than $9 billion in profits in fiscal 2015, placing the company at a forward P/E of less than 12.

2013 Annual Report, Source: Gilead Sciences. 

Amazingly, though, in large part because of expected growth in Sovaldi, Stribild, and new drug approvals, I believe Gilead has a genuine shot at growing by an average of 25% per year over the next five years. Doing the math, a forward P/E of 12 and a growth rate of 25% works out to a PEG ratio of less than 0.5!

I'm certainly willing to go on the record here as saying that if Gilead dips into the low $60's or below I will be pulling the trigger in my personal portfolio. This stock clearly isn't for everyone as it can be quite volatile, but biotech-savvy and more risk-willing investors should certainly devote some time to further research the amazing growth story that is Gilead Sciences.