Gilead Sciences (GILD): Cheap Dividend Growth Or Value Trap?
Gilead Sciences (GILD), the dominant antiviral and hepatitis drug company, is starting to draw a lot of attention from value oriented investors due to its decline of 23% over the past year.
Gilead’s stock now trades at a high-single digit price-to-earnings multiple which typically has many bargain hunters salivating, especially in a market where many quality blue-chip stocks and dividend aristocrats trade at over 20x earnings.
Furthermore, Gilead initiated a dividend in the second quarter of 2015 for the first time since the company’s founding in 1987 and now yields 2.4% with strong dividend growth potential.
With a low payout ratio, cheap P/E multiple, and a history of phenomenal growth, should dividend investors jump on the opportunity to own a stock that has returned nearly 400% over the last decade or are they getting lured into a value trap?
Gilead Sciences is a global biopharmaceutical company that discovers, develops, and commercializes innovative medicines in areas of unmet medical needs.
Gilead’s main focus is on human immunodeficiency virus (HIV), liver diseases such as hepatitis, oncology and inflammations, and cardiovascular and respiratory conditions.
In 2015, they generated sales of $32.6 billion, the most in company history. Their main competitors in the industry include other large global biotechnology and pharmaceutical companies. Their products compete based on efficacy, safety, tolerability, acceptance by doctors, ease of use, insurance coverage, distribution and marketing.
Gilead’s main therapeutics are Harvoni (Liver Diseases), Sovaldi (Liver Diseases), Truvada (HIV), Atripla (HIV), Stribild (HIV), Complera/Eviplera (HIV), and Viread (Liver Diseases). All of these therapeutics generated sales in excess of one billion dollars in 2015.
Gilead has significant revenue concentration from its main drugs. The company’s top ten drugs generated around 97% of their revenue in 2015 with the top three generating around 69%.
Furthermore, their top therapeutic, Harvoni, generated sales of about $13.9 billion, or nearly 43% of their total revenue for the year.
It goes without saying that dividend investors need to be very comfortable with the outlook for these drugs to ever consider investing in Gilead Sciences regardless of the attractiveness of the valuation and the current important financial ratios.
The patent protection periods on their top drugs look okay with Harvoni covered until 2030, Sovaldi until 2029, Truvada until 2021 (but only 2017 in the European Union), Atripla until 2021 (but again only 2017 in the EU), Stribild until 2029, Complera/Eviplera until 2022, and Viread until 2018.
Thus, with the benefits of patent protection lasting for at least 4-5 years on their major drugs, and much longer on Harvoni, then why are the shares so cheap today?
It all comes down to the market believing that Gilead’s best days are behind the company. After all, it’s hard to imagine the company’s surge in margins earnings the last few years will be repeated (or possibly even sustained).
As seen below, Gilead’s operating margins surged from roughly 40% in fiscal year 2013 to nearly 70% in 2015 thanks to high-priced treatments Sovaldi (FDA approval in late 2012) and Harvoni (released in October 2014). Diluted earnings per share increased by a factor of 10 from 2013 to 2015.
Product sales for their HIV and liver disease areas were down 1.3% for the six months ended June 30th, 2016, with the decline accelerating in the second quarter for a nearly 6% slump.
Even more concerning, U.S. product sales were down 12% year-over-year in the quarter and HCV product sales were down 33% due to lower revenues per patient as a result of increased rebates, discounts from payer mix, and less new patients starting Harvoni.
Harvoni is a major concern because sales are down over 22% through the first six months of the year. This trend is not getting any better as the sales decline accelerated in the second quarter of 2016 with sales falling nearly 29% from Q2 2015 levels in this key drug.
Furthermore, during the second quarter, Gilead slightly lowered its expectations for full-year sales from $30 – $31 billion to $29.5 – $30.5 billion. This implies that management expects sales to fall around 6% year-over-year from 2015 levels.
Let’s dig in a bit further to understand the key drivers of the declining sales.
Here is the CFO, Robin Washington, discussing the trends on the second quarter conference call:
“While we are seeing continued strength in non-HCV product sales, given the current trends in payer and patient flow dynamics for HCV, our updated models suggest net product sales will range from being slightly above to slightly below $30 billion for the year…The factors contributing to this conclusion include lower HCV revenue per patient as a result of a mix shift towards more heavily discounted payer segment in the U.S. and continues with a lower net average price in Europe, a trend toward slowing patient starts in the U.S. commercial segment and some earlier launch markets of Europe, a continued gradual trend towards shorter duration and loss of some market share to competition.”
These trends are clearly not good for Harvoni, which contributed well over 40% of their 2015 revenue. Sales could continue to fall if the current business trends continue and competition intensifies.
Furthermore, AbbVie and Merck have entered the HCV space with new products. If the competition’s new therapies continue to show promise, we would expect sales for Harvoni, and some of their other antiviral products to come under even more pressure.
Overall, there remains a lot of uncertainty surrounding the business. When looking for prospective investments for our Top Dividend Stocks portfolio, we do not like to see such sales concentration in top products because it significantly increases uncertainty and could lead to dividend cuts if a company’s financials really deteriorate.
While the biotech industry has numerous appealing qualities (e.g. high barriers to entry with steep R&D requirements and regulations; products can take 10+ years to develop; patent protection and intellectual property result in excellent margins for successful drugs), it’s nearly impossible to pick the winners beforehand and predict how new drugs in the pipeline will play out.
Making forecasts is further complicated thanks to healthcare reform changing consumers’ insurance policies, public funding issues for some of Gilead’s major customers, and increased industry scrutiny over pricing (e.g. Harvoni’s wholesale cost runs roughly $94,000 for a full treatment).
Dividend Safety Analysis
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. Gilead’s dividend and fundamental data charts can all be seen by clicking here.
Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.
Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at