DGI’s Dream or Sucker’s Bet? (GILD)

I am normally really cautious when I see the investing community going ballistic over a stock. I remember seeing dozens of articles on companies like GT Advanced Technologies, nearly all bullish. The investors behind them were rabid supporters of the stock, leading to some nasty exchanges on SeekingAlpha or other sites. Well, we all know how that turned out.  So when I see companies like Apple (AAPL) or Gilead (GILD), where the sentiment is nearly 100% bullish, I’m naturally hesitant to look deeper, since I’m not convinced there’s much more than hype there. But in the case of GILD, I’m not so sure. Based on the articles I’ve read, GILD actually seems to be a pretty successful company, with a strong pipeline and oodles of cash in reserve. So today, I’d like to take a look at the company myself to see whether my initial skepticism is warranted.

Quick Background:

From Scottrade:

Gilead Sciences, Inc. (Gilead) is a research-based biopharmaceutical company that discovers, develops and commercializes innovative medicines in areas of unmet medical need. The Company’s primary areas of focus include human immunodeficiency virus (HIV), liver diseases such as chronic hepatitis B virus (HBV) infection and chronic hepatitis C virus (HCV) infection, oncology or inflammation and serious cardiovascular and respiratory conditions. The Company has operations in North America, Europe and Asia Pacific. The Company’s products include Atripla, Truvada, Viread, Complera/Eviplera, Emtriva, Hepsera, Letairis, Ranexa, Lexiscan/Rapiscan, AmBisome, Vistide, Macugen, Cayston and Tamiflu. Sales of the Company’s antiviral products, which include products in the Company’s HIV and liver diseases areas described above, were $9.34 billion in 2013. This represented 83% of the Company’s total revenues in 2013.

The company is most well-known for its blockbuster drug Sovaldi (the updated version is named Harvoni), a treatment for Hepatitis C, itself acquired in 2011. GILD is also very active in the HIV space with the molecule tenofovir. The company itself was founded in 1987, and is based in Foster City, California. Other members in the biotechnology peer group include AbbVie (ABBV), Pfizer (PFE), Celgene (CELG), and Amgen (AMGN).

For more basic information, check out the company’s website and the 2013 annual report.

Fun fact: An investment of $10,000 in December 2000 would be worth $390,847.82 today, all dividends reinvested. This yields a annual rate of return of 29.4%, which absolutely crushes the S&P 500’s return of 4.3% during this time frame. (Source: FAST Graphs)

Investment Criteria:

SInce GILD doesn’t appear on David Fish’s list of dividend champions, contenders, and challengers, I will use my growth stock screening criteria to judge it.

• I may only invest in technology companies in sub-sectors I understand: No
• The company must have a ‘narrow’ or better economic moat, based on Morningstar’s judgment: Yes (Wide)
• The company must have a quality rating of ‘B’ or better (‘A’ or better preferred), according to S&P’s credit ratings: Yes (B+)
• Earnings must be on a consistent and significant uptrend: Yes
• FAST Graphs must show undervaluation based on the Normal P/E ratio (the blue line): Yes
• Expected return is 8% or more over the next few years, according to FAST Graphs: Yes (64.02%)

Other Bonus Ratings:

• S&P Capital IQ: 5-star Strong Buy
  • Scale is 1-5, 1 being ‘strong sell’, 5 being ‘strong buy’
• Thompson Reuters StockReport: 6 (optimized score of 3)
  • Scale is 1-10, 10 being best, 1 being worst
  • Optimized scores weight insider trading and price momentum heavier than other criteria
• Value Line: 3 for safety; 1 for timeliness
  • Scale is 1-5, 1 being best, 5 being worst
• Morningstar:
  • Moat: Wide
  • Stewardship: Exemplary

Financial Overview:

Interestingly for a biotech company, GILD recently announced they will be paying a dividend starting in 2Q2015. The quarterly dividend will be $0.43/share, $1.72 annually. At today’s share price of $100.29, this means GILD will have a dividend yield of 1.71%, pretty respectable for a biotech. With 2014 normalized earnings per share of $7.35, this yields an EPS payout ratio of 23.40%, a very safe number.

The company is debt-heavy, with a debt/equity ratio of 0.8. This is expected since it takes a lot of money to advance drugs through clinical trials. However, there are two important caveats. First, the company has $6.76 per share in cash and cash equivalents on the balance sheet, which is more than enough to cover the dividend if needed. Second, the peer group’s total debt/equity ratio is 2.2, almost triple GILD’s. This shows that higher debt is not uncommon in the space, and therefore isn’t extremely worrisome.

In the same announcement, they authorized a $15 billion share buyback program to supplement the $5 billion buyback renewal in May 2014. In 2014 alone, they spent $5.3 billion to repurchase shares. This buyback is extremely effective, as the company has been a share cannibal over the past five years. YCharts tells us that on March 31, 2010, GILD had 1.804 billion shares outstanding. Currently, the company has 1.489 billion shares outstanding, which represents a solid decrease. However, in the past, the company apparently helped fund itself through equity offerings, which lead to expansion of the share count over time. I am encouraged to see that GILD is reversing this trend.

The company splits proudly and regularly, with 2:1 splits in 2001, 2002, 2004, 2007, and 2012.

GILD’s current P/E ratio is 13.7, which is reasonable. Morningstar pegs the one-year forward P/E ratio at 9.2. Based on the explosive growth of Sovaldi, I suspect that the compression is a growth of earnings rather than price, and view this as a positive. GILD’s gross, operating, and net profit margins all crush the peer group’s: 84.78% vs 75.49%, 61.33% vs 15.69%, and 48.45% vs 17.92%.

Over the next three years, GILD is expected to grow earnings 10.2%, with an annualized rate of return (AROR) of 19.36% during that time frame. This is slightly below the more aggressive-growth peers like ABBV (22.84%) and CELG (21.89%), but the number still crushes its more-established peers like PFE (4.83%) and AMGN (5.78%).

For a more in-depth look at GILD, I’d recommend this SeekingAlpha article. Here’s Chowder’s analysis for another perspective, and Morningstar’s analyst report is available here as a PDF.

Risk Factors:

• Pricing – There has been a lot of outcry based on the price of GILD’s HCV treatment, which runs around $1,000 a pill, $84,000 for a 12-week treatment, minimum. Recently, Express Scripts (ESRX) signed an exclusivity agreement with AbbVie in order to sell ABBV’s drug Viekera Pak, a cheaper though less effective alternative. However, GILD has been fighting back by providing discounts in exchange for exclusivity, including with CVS Health (CVS). I’ve also read articles showing that GILD has struck a similar deal with Aetna (AET) and others, but of course I didn’t save it. Generally speaking, the USA is the only place where GILD can actually charge these prices. I feel that the price will by necessity drop in time, but even if they do, GILD will still have excellent margins and profitability. And don’t forget, lower prices means higher sales as more people can afford treatment, so price cutting may not be a big deal at all.

• A “dry” pipeline – The problem with biotechs and drug companies is that they need a large and stable pipeline in order to keep making money. GILD is currently relying on Sovaldi/Harvoni for the bulk of revenues. This isn’t necessarily bad since GILD can milk them for a while. However, they will go off-patent someday, and then what? I don’t see this as a big deal, as GILD has a pretty robust pipeline, with many drugs in Phase II or III in clinical trials. Further, GILD is expanding into oncology treatments; the company recently hired Dr. Phillipe C. Bishop from Genentech (RHHBY). I think this indicates that management fully understands the risks, and has no interest in resting on its laurels until Solvaldi/Harvoni expire.

• Safety – Pretty simple: if any of GILD’s drugs turn out to be ineffective when compared to other drugs, or worse, dangerous, the pricing and margins that GILD enjoys will disappear. I think the solid pipeline will mitigate this, but there’s always the chance it could happen.

Final conclusion:

Well, I admit, I was surprised. GILD actually looks like a very solid company. It passes all but one of my criteria. Even still, I feel it is a very easy company to understand: it researches drugs to treat tricky diseases like HCV and HIV. I am not thrilled by its debt, but don’t view it as a major issue either. I am also hesitant on dividend growth, but the dividend as-is is well-covered. Besides, I’m viewing this as a growth stock, not a dividend stock. In that regard, GILD seems to treat its shareholders right. This is not the safest or most stable company I’ve seen – few biotechs are. But at this point, I think it’s worth the risk. I rate GILD a buy, and seek to add it to my growth portfolio. Until I can add it, GILD will be placed on my watchlist.

What do you think? Does GILD make the cut for your portfolio? Also, how can I improve future analyses?

Disclosure: I am seriously considering selling my MLPs in the next few days, in order to simplify my taxes. GILD is high on my purchase list, and may be the stock I buy with the proceeds.

All data is accurate as of market close, 03/17/2015. My stock analysis archive page has been updated accordingly. Please read my disclaimer here before choosing to invest. Company logo image source is available here. Data source is FAST Graphs, David Fish’s US Dividend Champions List, or company materials, unless otherwise indicated.

Tags: GILD, Gilead Sciences Inc, growth-stock-analysis