GILD bear case

Saul asked for a GILD bear case. I don’t own it and after several people here indicated their enthusiam for GILD, I decided to have a look. I decided not to buy. Here’s why:

  1. Prior to last year (before Solvaldi) GILD seemed to not be growing…at least not when you look at revenue and adjusted earnings. During this time the vast majority of GILD’s earnings were from their HIV business.

	     Adj. EPS	Rev ($M)
3/31/2010	0.485	2090
6/30/2010	0.425	1930
9/30/2010	0.45	1940
12/31/2010	0.475	2000
3/31/2011	0.435	1930
6/30/2011	0.5	2140
9/30/2011	0.51	2120
12/31/2011	0.465	2220
3/31/2012	0.45	2282
6/30/2012	0.49	2405
9/30/2012	0.5	2427
12/31/2012	0.5	2588
3/31/2013	0.48	2532
6/30/2013	0.5	2867
9/30/2013	0.52	2783

Solvaldi launched in Q4 2013 and you can seem a big jump in earnings and revenue:

12/31/2013 0.55 3120
3/31/2014 1.48 4999
6/30/2014 2.36 6535
9/30/2014 1.84 6042
12/31/2014 2.43 7314

From the above, I concluded that their HIV business has stagnated. Looking at their pipeline, there are some more HIV drugs in various stages of clinical trials but I viewed this more as improvement products needed to maintain their market share as opposed to growth opportunities. So you have a $2B HIV business that is flat.

  1. Their HCV business is now huge. Solvaldi may be the biggest drug ever. However, now their is competition and GILD has had to cut prices. Therefore, I conclude that while the number of patients will grow for GILD’s HCV drugs, the revenue growth from here will be minimal (price cuts in 2015 may really affect the comps versus 2014). If you look at GILD’s revenue guidance which they just gave on 2/3/2015, total revenue is only forecasted to grow by about 6.5% in 2015. While there may be upside to the guidance, I am concerned about the competition.

  2. GILD is already a $140B market cap company. I tend to shy away from mega caps because smaller companies offer better growth potential.

Yes, there’s a chance that their HCV business will grow faster than GILD forecasts, I prefer to keep my money invested in companies that are demonstrating that they are growing much faster.

Chris

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Thanks Chris, I very much appreciate your evaluation, and on the other hand, Anirban sent me some links to MF write-ups by several paid services which like GILD. I tried to like GILD, and tried to want to take a position, but I have to say that I see it the same way you do, and agree with just about all your points, so I decided (just this morning) to stay out of it. That straight up sales trajectory seems finished. It may dribble on up slowly, but it’s just not my kind of company.

Thanks again, and thanks to everyone who expressed their opinion.

Saul

Hi Chris,
Thanks for bring the bear case to us.
I want to point out one thing and give a link to an SA article. Please let us know what you think after you read it.
The 2B revenue for HIV franchise you mentioned in your post is just for one quarter. So annual revenue should be around 10B.
Here is the link to the SA article:
http://seekingalpha.com/article/2693025-gileads-value-withou…

The main points from the author are:
1)Gilead ex-Sovaldi/Harvoni is extremely valuable.
2)Even without Sovaldi, 3rd quarter product sales increased 17%, which compares favorably to Gilead’s peers.

As you pointed out, GILD is already a large cap, I understand your concern and hence the decision of not investing in it.

Zangwei

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Hi Saul,

I’m not very familiar with CELG or to much on GILD either so I’d love your input. I know you have CELG so I was just wondering does the higher P/E for CELG compared to GILD still make it more favorable? Is this due to the market cap and growth rates? CELG’s P/E is a lot higher and higher than its growth rate so just wondering from a learning perspective why you like CELG over GILD. Thanks

Chad

3) GILD is already a $140B market cap company. I tend to shy away from mega caps because smaller companies offer better growth potential.

Hi GauchoChris,

Let’s not forget to add that GILD has excellent capital allocators and probably would do a good job picking smaller companies to buy, plus they have just added a dividend and buy back…is a split on the way? Yes, I know a split is cash neutral but when AAPL split I went in heavily, expecting the stock to rise which it did as it was a high profile stock (like GILD) yet too expensive at $700 for small timers to buy.

There’s the complete story. Discounts are now here (though we haven’t had a lot of revenue from Europe yet) and their revenue growth will not be so startling but that doesn’t mean they should be punished if they only grow their $27B in revenue by oh say, 30% - 40% in 2015.

And there’s this which is my reasoning for buying now:
Gilead is trading at an extremely low P/E multiple of 12 times trailing 12 months’ earnings. The low valuation of one of the biotech industry’s icons is exemplified when considering that the industry average P/E is 68.25. Furthermore, the price to cash flow multiple is a very reasonable 11.57 compared to the average of 46.68 for the biotech industry.

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I’m not very familiar with CELG or to much on GILD either so I’d love your input. I know you have CELG so I was just wondering does the higher P/E for CELG compared to GILD still make it more favorable? Is this due to the market cap and growth rates? CELG’s P/E is a lot higher and higher than its growth rate so just wondering from a learning perspective why you like CELG over GILD. Thanks Chad

Hi Chad, First of all make sure you read Chris’ GILD bear case, which starts this thread. I don’t want to hurt people’s feelings as a lot of people are very in favor of GILD, but here’s how I see it: GILD had a stagnant HIV business until about a year ago. Then they introduced their hepatitis C medication at $84,000 a pop (for a cure) and in the last year they really took off. Now they anticipate having to increase their discount from the previous 22% discount from the stated price to their estimate an average discount of 46% from the stated price in 2015. Plus there are more and more competitions entering the market, plus all those millions of people in Africa and where ever with hepatitis C that they keep quoting are never going to get this medicine even at a 75% markdown. Also this is not a continuing treatment like for HIV. It’s the low-hanging fruit in the US first, but once they are treated they are treated, and you never see them again. Even in Europe, most countries won’t accept a 46% markdown, they’ll ask for a 90% markdown, or more. (Example, Nasonex nasal spray costs $250 or more in the US for a little bottle. In France it sells for about $12, and the drug company must be making some money on a $12 price or they wouldn’t be selling it. The health system is government run and the government sets the prices. And Spain, Italy and the rest don’t have the money to pay $84,000, or half that.) The big rise is over.

On the other hand, look at Celgene: Here’s their earnings in pennies for the past 12 quarters

54
61
65
66
69
76
78
76
84
90
97
101

(They had a 2 for 1 split so some values were half cents which I rounded up as half cents didn’t make any difference for the illustration). It’s a consistent and steady rise, year-in, year-out.

Yearly earnings were
2011 1.90
2012 2.46
2013 2.98
2014 3.71

For 2015 they estimate 4.60 to 4.75
For 2017 they estimate 7.50
For 2020 they estimate 12.50

Yearly revenues were
2011 4.8 billion
2012 5.5 billion
2013 6.5 billion
2014 7.6 billion

For 2015 they estimate 9.0 to 9.5 billion
For 2017 they estimate 13 to 14 billion
For 2020 they estimate OVER 20 billion

They always keep raising their estimates and always beat them. They have a bunch of active medications which keep getting approved for more and more indications. They have lots more in the pipeline. They sponsor lots of little biotech for the right to market their meds in the future. This company is all about the future, while I see GILD as all about how great 2014 was.

JMHO, and I know I’ll outrage lots of people.

Saul

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Celgene the company probably has a brighter earnings future than Gilead the company. But the stocks are priced as if CELG has 2.8 times better future than GILD. P/E 49 vs 17 (quick figures from MF)

I don’t know if that will turn out to be true or not. They are different types of companies, one with high expectations, one with low expectations. GILD only has to do a little bit better than average, CELG has to do a lot better than average. A bear market (damping expectations) will hit CELG harder.

Investing in one does not exclude investing in the other, it’s not either-or.

Part of the reason I own GILD is to balance smaller cap higher P/E companies that I own.

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Saul et al,

I appreciate the response with regard to Gilead and it doesn’t outrage me at all. In fact, just the opposite as I want to hear differing views.

I don’t have the numbers handy, but you posted earnings growth for CELG. If you look at 2014 growth for GILD it is simply amazing. Looking beyond, we will not see that same type of growth, but we will see a cash generating machine that is well-managed and can deploy cash, as they did with Solvaldi, to make late-stage acquisitions.

Surely, we do not know how future acquisitions will develop, but one data point shows that it worked tremendously. In fact, Sovaldi was likely the most prodigious drug release in history.

Couple the above with the fact GILD trades at an incredibly low PE and you have great potential in the making.

As others and I have written, I view GILD in the same boat as AAPL was when trading around $400 pre-split. One incredible product generating enormous cash flows at an incredibly low PE. Buy and wait.

I’d love to hear why others think differently.

Take care,
A.J.

Thanks Saul. That was very insightful and helpful.

Chad

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One thing about these AAPL and GILD comparisons … beyond the very reasonable observation that they are not meaningfully comparable … has to be the recognition that AAPL is where it is because of a successful pattern of serial innovation. Before the prior innovation got tired, they have managed to produce a new one. Where would AAPL be today if the last innovation was the iPod? And, I keep wondering when it is going to end … if it does, there will be a real crash in the stock, even if the company is still making money hand over fist.

GILD is very different. A solid history and base, a new superbomb, questions about how the initial expected return on that superbomb might be trimmed, and who knows about beyond that … not that one knows about AAPL, of course. The really strong issue with GILD seems to me to be that the questions about pricing have depressed the stock disproportionately. After all, we aren’t talking about an $80,000 product that takes $70,000 to produce, we are talking about an $80,000 product that takes maybe $1000 to produce, so one can afford to discount, a lot and still make bundles of money. It’s a cure, folks. Yes, that doesn’t mean recurring revenue, but it means that it is extremely attractive to insurance firms who would otherwise be out of pocket for indefinite period for treatments. Even at the original price, it was attractive in this regard, so I question just how deep the price pressure is going to go unless there is another genuine cure.

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Celgene the company probably has a brighter earnings future than Gilead the company. But the stocks are priced as if CELG has 2.8 times better future than GILD. P/E 49 vs 17 (quick figures from MF)

I don’t know if that will turn out to be true or not. They are different types of companies, one with high expectations, one with low expectations. GILD only has to do a little bit better than average, CELG has to do a lot better than average. A bear market (damping expectations) will hit CELG harder.

Investing in one does not exclude investing in the other, it’s not either-or.

Part of the reason I own GILD is to balance smaller cap higher P/E companies that I own.

I loved how well you explained this. This is exactly why I hold both. GILD is dirt cheap for the drugs in its portfolio & pipeline, and the cash on the balance sheet. GILD’s management have been excellent capital allocators. GILD is more of a value play compared to CELG which is a pure growth play.

Anirban

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GILD is dirt cheap for the drugs in its portfolio & pipeline, and the cash on the balance sheet.

In case you’re not aware, the balance sheet has more long term debt than cash.

Chris

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In case you’re not aware, the balance sheet has more long term debt than cash.

That is just one data point and they almost have enough cash to pay off all of their long term debt. Not their short term debt but their long term debt. They have approximately 8 billion in long term debt but their FCF is approximately 9.4 billion. I don’t think I would be worried about long term debt.

Andy

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Celgene the company probably has a brighter earnings future than Gilead the company. But the stocks are priced as if CELG has 2.8 times better future than GILD. P/E 49 vs 17 (quick figures from MF)

Hi Mauser,

“quick figures from MF” are wrong, as a quick look at Celgene’s last four quarters would have shown. Earnings for 2014 were $3.71. Price is $120. PE ratio is 32.

For 2015, Celgene predicts $4.60 to $4.75. They always beat early predictions, but let’s just figure $4.75. That gives a PE of 25.

For 2017, Celgene estimates $7.50, PE of 16. Will certainly beat that.

There’s a reason that CELG sells at a higher PE than GILD. GILD is a big company. You aren’t the first to notice that their PE is so low. The whole market must know it. Why aren’t people gobbling it up and raising the price and the PE? The market must have its reasons. This isn’t some little company that got lost and misplaced in the shuffle. That’s all that the market thinks it’s worth.

Just thinking.

Saul

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There’s a reason that CELG sells at a higher PE than GILD. GILD is a big company. You aren’t the first to notice that their PE is so low. The whole market must know it. Why aren’t people gobbling it up and raising the price and the PE? The market must have its reasons. This isn’t some little company that got lost and misplaced in the shuffle. That’s all that the market thinks it’s worth.

Hi Saul,

I generally believe that the market is good at attaching premiums to companies. But every now and then there are opportunities where mis-pricing occurs. Last year it was Apple. Apple is up some 50% from its low and Apple is a mega cap. Of course, we are able to identify the mis-pricing now with the benefit of hindsight.

Similarly, some think that GILD is mis-priced if one takes 2-3 year view. It’s true that the majority disagree but that doesn’t in any shape or form prove that GILD will not be a market beater 2 to 3 years out. I would say the dividend program plus a bit of above expectation performance, and some evidence of the price war coming to an end might be all that’s needed to give a multiple boast. Couple that with GILD’s buyback program and I smell healthy gains in about a two year timeframe.

Anirban.

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One more thing that FCF is for 9 months so after a year it will probably be around 12 billion. 12 Billion FCF in one year.

Andy

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That is just one data point and they almost have enough cash to pay off all of their long term debt. Not their short term debt but their long term debt. They have approximately 8 billion in long term debt but their FCF is approximately 9.4 billion. I don’t think I would be worried about long term debt.

Not a worry but one reason Anirban gave for owning is the cash on the balance sheet. Net cash was negative as of 12/31/2014.

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Chris,
That makes sense but I don’t worry about the long term debt, I look at the short term debt to see if they can service it. I think about it as a mortgage. If a company has enough free cash flow and cash on the balance sheet the long term debt should be no problem. I know you know this but I think it is educational for other users on this board. If anyone sees something wrong in what I stated please speak up. We all learn from these discussions.

Andy

Barron’s on GILD

http://blogs.barrons.com/stockstowatchtoday/2015/02/11/gilea…

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