Herein we discuss several important drivers for Gilead Sciences, Inc. (NASDAQ:GILD) shares going into 2Q15/2016. HCV remains important and the growth is not over, we discuss where we see upside to estimates from such as Italy and EM. Moving beyond HCV is vital for P/E multiple expansion toward its peer group median of ~19x 2016E. Everyone expects M&A; we focus our analysis where GILD should focus its BD activities (not VRTX, or CF) and we put forth a timeline that could skew GILD’s bias toward one particular therapeutic area over others for an acquisition. Moreover, we believe GILD needs to focus its M&A toward addressing sustainability over the next 20-30 years not masking the underlying problem by acquiring VRTX.
Gilead Sciences is due to report 2Q15 earnings on 7/27/15 that is unlikely to itself be an upside catalyst for GILD, with the risks skewed to the downside given abnormally low Implied VOL, despite the ATM Straddle pricing in +/- 6.5% move vs. the +/-6% historical average (rolling 8-quarter) implied move that has been priced into options ahead of earnings. We consistently have sold strangles immediately ahead of the earning release profitably, however the low Implied VOL doesn’t support such a strategy at this time. Should this change before then (which we expect), we would give serious consideration to selling weekly strangles outside the range implied by the ATM straddle. We expect GILD’s implied VOL to continue to increase into JNJ’s (7/14/15) and ABBV’s earnings (7/24/15) whose HCV commentary could be as significant as their own. Any additional clarity on JNJ’s recent collaboration with ACHN should be meaningful for assessing the future treatment landscape in HCV, but could be especially negative for ABBV. We suspect GILD’s implied VOL to peak on the day before ABBV reports on 7/24/15.
Major HCV forces on both GILD & ABBV shares will be driven by Vikeira Pak’s Gross-to-Net discounting, as well as net sales during 2Q15. Note, GILD stated during 1Q15: “won’t discuss G/N ever again this year.” Should 2Q15 results disappoint this would be a significant opportunity to position for 2H2015 catalysts (pipeline, M&A). Recall, ABBV’s launch of Viekira Pak was somewhat delayed due to “most of their contracts don’t go into effect until the second-quarter,” and IMS data is being blocked by Express Script’s (ESRX) limiting visibility.
Our expectations for GILD’s 2Q15 are $2.80 EPS (cons. $2.65), and assessing the impact from an accelerating ex-US HCV launch. We expect GILD to generate $3.21B in total US HCV sales (cons. $3.1B) & $4.277B WW. Total operating revenues of $7.65B (cons. $7.53B), offset by 89% gross margins, and $2.3B in quarterly operating expenses that we expect grew 15-20% over 1Q15 should drive 2Q15 EPS of at least $2.80 (cons. $2.65), but could easily achieve $3.00/share should operating expenses be in-line with 1Q15, and/or share repurchases exceed our $3B estimate at a lower average repurchase price.
We expect at least $3B of share repurchases at $110/share during 2Q15. This in conjunction with seasonal drug shipment patterns provides the highest probability of beating consensus (and our est.) handily. Additional catalyst from the call could come from M&A theorizing in Fibrosis, NASH, and Oncology.
Overall, 2Q15 earnings for large-cap biotechnology companies will be difficult to beat due to a tough 2014 comparison base (2014 Sales and Earnings grew ~4X the average growth rate of 2010-13), compounded by increased pricing pressure. After analyzing the historical effects of risk aversion, and Fed rate hikes on the biotech and pharmaceutical sectors, the potential for sector weakness under the backdrop of Greece, ISIL, & Iran are elevated. But in our view, Healthcare/biotech seasonality suggests during the 3Q. Couple this with numerous value unlocking catalysts across the sector, the strong large cap fundamentals continue to support a large cap overweighting as we continue to believe in the long-term bull case. SMID Cap allocation should be focused on those with late-stage de-risked pipelines with a high probability of being acquired (INCY & CLVS remain our two top picks since the 2Q14 correction for multiple acquirers).
In our view, GILD exemplifies how inefficient markets are at valuing companies in the sector. With GILD trading at more than -50% discount relative to its peer group on a NTM P/E basis despite having not only the highest EBIT margins, but also the highest LT ROE in the industry.
We could see GILD’s multiple migrating toward 17x our 2016E EPS of $13.67, implying $232 per share and GILD would still be trading at a -20%+ discount to the median of its peer group. Of course this scenario is contingent on transformational M&A and/or simtuzumab succeeding in NASH and IPF.
13x our 2015E EPS of $11.24/share (cons. at $10.79) and a $146 PT by year-end, or 29%+ additional upside by year-end consistent with the past 2 years. We see GILD earning close to $11/share ($10.83-$11.19) dependent on HCV discounting & share repurchase assumptions for FY2015E.
We apply the percent decline from the 1H2014 Biotech sell-off where GILD corrected -25%. Applying this to its all time high of $123.37 yields a $92.52 “technical floor value,” that is also roughly inline with its historical trough multiple of 8x applied to our $11.24 in EPS representing a possible “fundamental floor value” of $90 for the stock.
- We are comfortable selling Puts between the $90-$100 strike on any sustained weakness from global macro concerns (Greece etc.).
- Long–Term oriented investors should accumulate between $100-$110 (8x our 2016E), which would translate into at least a 4+% dividend yield by 2020E based on our share repurchase & dividend growth model.
- Event-Driven traders such as ourselves are looking to trade earnings, but we expect implied VOL in GILD options to climb into JNJ’s and ABBV’s earnings, and peak the day of or prior to ABBV’s earnings 3 days before GILD reports on 7/27. We would be looking sell strangles outside the range implied by the ATM straddle on or about 7/23 or 7/24.
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