Without A Clear Growth Path, Gilead Sciences Is A Hold (NASDAQ:GILD)

Introduction

The healthcare sector is always interesting, especially when there is some uncertainty regarding private consumption. With higher interest rates than a decade ago, consumption may grow slower. Healthcare products are one thing that people tend to keep spending on. Therefore, healthcare spending tends to enjoy a more stable growth path than discretionary spending.

In my dividend growth portfolio, I own several healthcare companies. Some are pharmaceuticals, and others produce medical devices. One company that has been on my watchlist for several years is Gilead Sciences (NASDAQ:GILD). The company is a diversified pharmaceutical company with a growing record of dividend increases. It may be an attractive addition to my portfolio if it has enough growth opportunities.

Seeking Alpha’s company overview shows that:

Gilead Sciences discovers, develops, and commercializes medicines for unmet medical needs in the United States, Europe, and internationally. The company provides products for the treatment of HIV/AIDS, an injection for intravenous use, for the treatment of coronavirus disease 2019, and for the treatment of viral hepatitis. It also offers products for the treatment of oncology, an oral formulation for treating pulmonary arterial hypertension, and a liposomal formulation for treating severe invasive fungal infections.

Fundamentals

The revenues of Gilead Sciences have increased by 145% over the last decade. The revenue growth can be attributed to organic and inorganic growth due to acquisitions. These acquisitions include Kite Pharma for cell therapy, Immunomedics for oncology, Forty Seven Inc. for immuno-oncology, and MYR GmbH for hepatitis delta virus, diversifying its offerings and addressing unmet medical needs. While the figure looks impressive, the company has seen stagnated sales for most of the last decade, implying that it struggles to grow. In the future, as seen on Seeking Alpha, the analyst consensus expects Gilead Sciences to keep growing sales at an annual rate of ~2% in the medium term.

The EPS (earnings per share) has increased by 154% over the same period. During that decade, the company maintained a 40% operating margin, but with the stagnating sales, even the aggressive buybacks were not enough to support growth. With high margins and significant share buybacks not enough to increase EPS, the company must increase sales to achieve EPS growth. In the future, as seen on Seeking Alpha, the analyst consensus expects Gilead Sciences to keep growing EPS at an annual rate of ~5% in the medium term.

The company is a relatively new dividend-paying company. It has been paying a dividend since 2015 and has grown annually. While the dividend growth streak may not be very long, it has some promising aspects. The current yield is 3.7%, a relatively high dividend yield for a healthcare company. Moreover, the dividend is likely safe, with the payout ratio at 64% using GAAP EPS and 45% using non-GAAP EPS. That leaves the company with enough room to invest in future growth prospects while increasing the dividend in line with the EPS growth.

In addition to dividends, the company returns capital to shareholders via buybacks. Over the last decade, the company has been buying back its shares aggressively. These share repurchase programs decreased the number of outstanding shares by almost 20% in the previous decade. Buybacks support EPS growth as they lower the share count, allowing companies to achieve a higher EPS with the same net income. Buybacks are highly effective when the share price is low, but should not be used instead of strategic investments.

Valuation

The company’s P/E (price to earnings) ratio stands at 11.95 when using the 2023 EPS estimates and 11.17 when using the 2024 EPS estimates. The current P/E ratio aligns with the valuation we have seen over the last decade. While the valuation seems attractive, investors should remember the stagnation that the company has been dealing with. If it manages to find its growth path, the valuation is attractive. Until then, I believe it is a fair valuation.

The graph below from Fast Graphs also shows that the company is fairly valued. Over the last two decades, the average P/E ratio of the company has been 18.6, a much higher P/E ratio compared to the current one. At the same time, the average growth rate was 24% annually, a much higher growth rate than the forecasted 5%. Therefore, it looks like the share price is looking for direction. The company trades at a lower valuation with a lower growth rate, and I believe it is fairly valued.

Opportunities

The most prominent growth opportunity is the expansion of the oncology portfolio. Gilead’s oncology segment continues to drive growth, with a 33% increase in sales in the third quarter, reaching an annualized revenue of over $3 billion. Trodelvy, the TROP2-directed ADC, demonstrated robust sales growth of 58% YoY, now reaching $283 million. The positive data from Trodelvy’s Phase 2 EDGE-Gastric trial and its potential in first-line metastatic upper GI cancers, as presented in the ASCO plenary session, highlight a promising expansion opportunity in the oncology market.

“With clear momentum and a solid infrastructure in place, in addition to our compelling clinical pipeline, we look forward to providing more patients with potentially new and effective options.”

(Daniel O’Day, Chairman and Chief Executive Officer, Q3 2023 Conference Call)

Another growth opportunity is the company’s advancements in its virology programs. Gilead’s virology programs, particularly in HIV treatment and prevention, present growth opportunities. Biktarvy, a leading HIV therapy, achieved a 12% YoY sales increase, contributing to a 9% growth in HIV overall in the first nine months of 2023. Lenacapavir, a long-acting oral integration inhibitor, shows promise in HIV treatment. Phase 1 and 2 trials are underway, and Phase 3 trials are expected to share data in early 2024, possibly increasing future sales in the company’s primary business segment.

“In HIV treatment, we reviewed promising data from the Phase 1 study of GS-1720 or once-weekly long-acting oral integration inhibitor to be combined with lenacapavir and Phase 2 ARTISTRY-1 trial evaluating a once-daily oral lenacapavir and bictegravir combination.”

(Daniel O’Day, Chairman and Chief Executive Officer, Q3 2023 Conference Call)

Another small opportunity is the expansion of cell therapy. Gilead’s cell therapy segment, led by the acquisition of Kite, continues to grow, with third-quarter sales reaching $486 million, a 22% YoY increase. Yescarta and Tecartus, Gilead’s CAR-T cell therapies, demonstrated strong sales growth. With only about 10% of eligible second-line large B cell lymphoma patients in the U.S. currently treated with cell therapy, there is significant untapped potential for further adoption. However, the segment is still small in general.

“As cell therapies are offered and delivered to more and more patients, we are confident that Kite remains well positioned to benefit from this expansion with its differentiated overall survival data for Yescarta and industry-leading manufacturing capabilities.”

(Johanna Mercier, Chief Commercial Officer, Q3 2023 Conference Call)

Risks

The company depends on Veklury, Gilead’s therapeutic option for hospitalized COVID-19 patients. It saw variable sales, declining by 31% YoY in the third quarter. The performance is highly dependent on COVID-19-related hospitalizations, making it vulnerable to changes in the pandemic landscape and potential shifts in treatment protocols. So, despite being a leading Covid drug, there is a high level of uncertainty. As the pandemic is phasing out, drug sales will likely decline in the medium term, hurting EPS growth.

“While the COVID environment remains ever-changing, Veklury’s performance in the third quarter further reinforces its established role as a key part of the standard of care for patients hospitalized with COVID-19.”

(Daniel O’Day, Chairman and Chief Executive Officer, Q3 2023 Conference Call)

Another risk is the market dynamics in the HIV segment, which accounts for more than 60% of the sales. Although the HIV treatment market continues to grow, the favorable pricing dynamics that contributed to previous sales growth are beginning to normalize. The third-quarter results indicate a shift in channel mix affecting average realized prices. Gilead acknowledges the normalization of pricing dynamics, emphasizing the need for adaptability in the competitive HIV market.

“This was evident in the third quarter where HIV sales were up 4% year-over-year to $4.7 billion, driven by higher treatment and prevention demand and higher channel inventory, partially offset by lower average realized price due to a shift in channel mix.”

(Johanna Mercier, Chief Commercial Officer, Q3 2023 Conference Call)

The last prominent risk is more general and is the continuation of stagnation due to pipeline risks and discontinuations. Gilead’s diverse clinical pipeline carries inherent risks, with 27 programs in Phase 2 and 19 in Phase 3. The discontinuation of the magrolimab ENHANCE and ENHANCE-2 programs based on futility analyses underscores the uncertainty in clinical development. The need for constant success makes it harder to maintain growth, as the company must continually replace its previous blockbusters to sustain growth. Without it, the current stagnation may continue.

“As is expected with the diverse and large clinical portfolio, not all our programs will benefit patients the way we hope they will and the ENHANCE and ENHANCE-2 programs evaluating magrolimab have both been discontinued based on futility analyses.”

(Merdad Parsey, Chief Medical Officer, Q3 2023 Conference Call)

Conclusions

Gilead Sciences is a tricky company. It has shown long-term growth in sales and EPS that led to a growing dividend. However, it has also suffered from stagnation over the last decade. It has several growth opportunities in oncology and HIV mainly, but investors are right to be concerned with their execution capabilities due to the stagnation. There are risks, but there is also a margin of safety in the valuation to accommodate them.

Generally, a company growing at a single-digit growth rate trading for 11 times earnings would be a decent investment. However, the company has been struggling to grow for too long. Therefore, I believe that the shares of Gilead Sciences are a HOLD. I may find them attractive either at a P/E ratio of 8-9 or when the company finally proves that it can bring solid growth in sales.