Between 2017 and 2021, net profits from the sale of Sovaldi and Harvoni ought to total somewhere around $70 billion. Based on current trends, about $30-$40 billion of that will go towards dividend payments and share repurchases that benefit the shareholders of Gilead Sciences. This means that Gilead stands to have at least $30 billion in the next five years that can be used to make acquisitions and develop other drugs.
For this reason, I consider Gilead’s current market cap of $99 billion, compared to almost $15 billion in annual profits, to be a signal of deep value at a P/E ratio of 6.7x earnings. This is crazy.
I cannot think of another time in which a stock was trading at this cheap of a valuation while bringing in more than a billion dollars in profits per month. I do understand why it has become generally disfavored–Merck has brought to market a drug called Zapatier that costs $54,600 for Hepatitis C treatment that suggests Gilead may have to bring down the price of its $94,500 Harvoni treatment to remain competitive. But that is only having the effect of slowing down Harvoni’s growth rather than taking away market share. There are 180 million people in the world affected by Hepatitis C, and about 30 million of them are capable of paying advanced economy prices for the treatment. The market is so vast that it can handle multiple competitors (just as Nike has still grown earnings alongside the rise of Under Armour.)
My rationale for a Gilead investment right now is threefold:
#1. As noted above, Harvoni and Sovaldi continue to make $27 million in net profit per day. They are absolute cash cows that will give Gilead billions of dollars in the next five years that can be used to make acquisitions. Coupled with the $8 billion cash hoard, Gilead will be making significant acquisitions in the coming years. It is my contention that acquisitions funded primarily through cash–rather than the issuance of new shares and/or debt–are not priced into the market ahead of time. You can spot these by finding businesses sitting on sizable cash positions with a high amount of retained earnings coming in.
#2. Gilead is showing signs of becoming more than Harvoni and Sovaldi. In June, Gilead received FDA clearance for its new drug Epclusa that is the first pill to treat all strains of HCV. This has billion-dollar profit potential over its lifetime. Additionally, it has five clinical trials that are pending in the next six months that may also provide hints of Gilead’s income streams to come. These prospects are independent of the cash that can be used to fund hypothetical acquisitions.
#3. The stock is just too darn cheap. If Gilead were trading at $125 per share, I wouldn’t talk about it publicly. The risks that everyone talks about would keep me away. But that is not the case–you get the chance right now to initiate a position at under 7x earnings. At that low of a valuation, you can absorb nearly the worst case scenarios and still eke out mid single digit returns. It is being priced as if its signature drugs go off patent this year and will be brutalized by generic competition immediately. But based on its five years of remaining patents and profit maintenance in the face of Zapatier, that view is too pessimistic. In retro Buffett parlance, I see it as a cigarette with five puffs left that is being priced by the people walking down the street as though it’s only got one gasp left.
I do not mean to be dismissive of the risks. If I were running a concentrated portfolio, or making a sizable investment for a retirement account, I would not choose Gilead Sciences as my stock of choice. It does have an undiversified business model whose core profit engines are subject to substantial profit erosion a few years from now. But the combination of current pipelines, as well as current cash plus enormous retained future profits, means that you are being compensated very well for this risk at less than 7x earnings. At $74 per share, I peg it at 13% to 15% annual compounding over the next five years. I would be deeply surprised if, over the medium term, Gilead failed to beat the S&P 500 Index from this price point.