- Massive Q1 growth at Gilead Sciences, Inc. (NASDAQ:GILD) – 52% revenue growth, 85% net income growth
- Market fears that Gilead is a US-focused, one-trick pony
- International growth, good track record of acquisitions, strong R&D pipeline all point to Mr. Market missing the point
- Integration with the largest generic manufacturers in India protects core markets
- Strong shareholder value creation model in place
After announcing record earnings last week, it’s a mystery to me why the market doesn’t respond to Gilead Sciences results. Massive growth, raised guidance and an excellent R&D pipeline should have investors keen to buy, but the market has barely responded to any of this. In fact, year-to-date, the share is only up around 10%. Looking at their international opportunities, good strategic handling of generic threats and the focus on shareholder value creation funded out of operating cash flows and the picture becomes even more compelling. Needless to say, this is the sort of opportunity we love to see. Here’s why.
So far, Gilead has been quite masterful in acquisitions. The basic model works one of two ways – the first is the standard biopharma acquisition model of paying a 50%+ premium on the business. Alternatively, they look to provide seed funding to an idea to limit exposure. If the idea pans out, buy it outright.
Its acquisitions to date have all resulted in value-accretion with 4-5 years and some made during the downturn have phase II and III trials that look very promising indeed, particularly in the oncology, HIV and HCV spaces.
Furthermore, they have bolted on a few acquisitions that have helped speed up testing, research and manufacturing times as well as purchasing a commercial manufacturing site in Ireland which they snapped up for half the build price.
All of this points to a management team that understands it’s target market well and is rapidly growing a productive offering while doing some interesting work to control costs and time-based issues.
Shareholder Value Creation
Having just completed a $5b share buyback programme in March, the board has agreed to buy a further $15b worth starting in April 2015. Given the forward guidance and the growth expectations, I think this is a good move as it can easily be funded and rewards long-term holders. At current levels, this is one year net income and could basically be funded out of operating cash flow. Those of you who have followed me know that I don’t appreciate debt-fueled buybacks that often leave the business highly leveraged – this buyback is more my style.
The board also agreed to declare the first quarterly dividend. While the first year yield is only around 1.7%, I can see this cash cow becoming a dividend king in time and I like the mix of offering both a dividend and a buyback.
Patent Expiry and Generics
The obvious risk in any pharma business is patent expiry and generic drug manufacturers. To date, it appears Gilead has managed this quite well, teaming up with large-scale generic manufacturers in India and agreeing licenses that cover the rest of the world. I like this approach as it is proactive and helps them get ahead of this curve. There are still obviously risks, but it’s a decent hedging strategy. As for their patent expires, the bulk of their revenues come from patents set to expire between 2017 and 2030 – with their blockbuster drugs, Sovaldi / Harvoni, set to expire in 2030.
Harvoni and Sovaldi have gone into generic manufacture in Egypt and there already seems to be some dispute about licensing and conditions. Given that the Gilead market is predominately US and Western Europe, I don’t see this as a major issue just yet, but may become one in the future.
One potential ‘cat’ amongst the pigeons is the current patent dispute with Merck (who bought Idenix) and AbbVie on Sovaldi. This is on-going and despite a UK ruling being due in November last year, I can only find argument and conjecture online. This is a cause for concern, but is likely to result in a less than 10% royalty to Merck (as that is what they requested) in the worse case and 0 cost in the best case.
The strength rating is 99 and we can see that the Z-score reflects the safety and relative strength of this business. Liquidity and solvency ratios are all fantastic and the business is prudently run with a great net working capital / net current asset position.
The timing rating is 58 and shows that the business has traded up slightly but has been pretty flat.
The returns rating is 100 and we can see that this is reflected in the Greenblatt rank / Magic Formula investing position. Returns across the business are good and rising.
The intrinsic value rating is 23 which is low – the business currently has around $3.43 of tangible book value per share.
The dividend rating is 0 which is low as they are only embarking on their dividend program. Expect this to rise.
The earnings predictability rating is 100 which demonstrates how they have consistently grown the top and bottom line at both an income statement and per-share level.
Our fair value comes in at $128 and this is a big step upwards, reflecting the growth in the business. This is a bit of a concern but we also know that our valuation has been held back in the last period as we look to control insane valuation jumps that are inconsistent with performance. Our target entry point is below $111, which offers us a $17/13.28% margin of safety and means the current price is well below our target entry price.
The income statement shows the massive growth brought on by Sovaldi / Harvoni.
The balance sheet shows the leap in equity but also a fair increase in long term financing.
The cash flow shows the massive $17b of cash flow generated through operations. We can also see the impact debt, the buyback and the declared dividend are having, all the while still growing the cash pile by over 50%.
Ultimately, we can safely say we like Gilead and that we will probably be initiating a position shortly as our timing score should change in the next few days with some sustained upward movement. While it is rated a hold at the moment, we do like the long-term prospects and see this business throwing off a lot more cash in the future.