Better Buy: Illumina or Gilead Sciences?

By Todd Campbell, Michael Douglass, and Gaby Lapera Markets Fool.com

Gaby Lapera, host of the Industry Focus: Financials podcast, made it her New Year's resolution to buy at least five stocks this year, one from each sector of Industry Focus.

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Illumina(NASDAQ: ILMN) andGilead Sciences(NASDAQ: GILD) are healthcare goliaths that are disrupting their industries, and each of these companies has catalysts on deck that could reward investors in the future. Is one of these stocks a better buy for long-haul portfolios than the other?

In this episode of The Motley Fool's Industry Focus: Healthcare podcast, analysts Michael Douglass and Gaby Lapera are joined by Todd Campbell to discuss the pros and cons of these stocks, and how each of them could reward patient investors down the road.

Tune in to find out what makes both companies so appealing and what makes them such different investments; how Illumina's sequencing machines will likely change the field of healthcare at large; why Gilead is such a great long-term play even though the stock is down approximately 10% this week; and more.

A full transcript follows the video.

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This podcast was recorded on Feb. 8, 2017.

Michael Douglass:Hello, everyone! Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. You're listening to the Healthcare edition, recorded today on Wednesday, February 8th, 2017. My name is Michael Douglass, subbing in for Kristine Harjes, and joining me today are Todd Campbell, Industry Focus: Healthcare's regular contributor, and special guest, Gaby Lapera. Welcome, folks!

Gaby Lapera:I just need to say something really quick. Michael, your podcast voice is very different from your real life voice, and it's really off-putting.

Douglass:Well, I'm sorry you feel that way. Todd appreciates me for who I am.

Todd Campbell:I do, I love your voice! As a matter of fact, it's been awhile since you've been on the Healthcare show, so I'm loving it even more today.

Douglass:You're very kind. As listeners might know, Gaby is joining each episode of Industry Focus this week to basically get pitched stocks. We work hard, and then she renders her decisions. So Todd and I are going to do that. But first, Gaby, I know you have some ground rules for this, so why don't we go over those?

Lapera:Yeah. This is part of my New Year's resolution, I don't know if you guys remember, I said I was going to buy stock in every sector of Industry Focus. But, the important thing to remember is that Michael and Todd are not pitching me personal ideas and advice. These are just companies that they like in their real life. I believe that Michael, in fact, ownsGilead. And when I say believe, I mean that I know, because he reminds me literally every day.

Douglass:Noteveryday.

Lapera:Almost every day. [laughs]

Douglass:There aredays I don't remind you.

Lapera:On Sundays, because I don't see him. [laughs] So, none of this is going to be personal advice. You should not take it as personal advice for you, either. This is just, "We like these stocks, we're going to talk about them." The other things that I want to let you guys know about is that The Motley Fool has a disclosure policy. We must publicly disclose if a contributor -- so, any of us -- have an interest in any of the stocks mentioned. Additionally, Fool employees work under trading restrictions which requires that employees hold any stock they own for 10 days because we're not day traders, and also because that's just a good idea. Ideally, you're holding it for much longer than 10 days, but stuff happens. We can't write about a stock in the period of two market days before to two market days after purchasing or selling a stock, which means that I'm not going to be able to buy any of these stocks for a while, because we're also going to do another show where we talk about some other stuff. So, don't go looking at my profile and be like, "Hey, Gaby, where are the stocks?" It's going to take a little bit of time. Also, we are required to notify our compliance department anytime we buy or sell stocks, and at this is in the interest of transparency to all of our listeners/readers. We want to do that, we want to be a good company.

Douglass:Yeah. And sometimes the appearance of malfeasance is really quite bad enough on its own, so we want to make sure that there is no possible perception issue, that we are being 100% transparent and clear about this.

Lapera:Did they audit you? They audit us every once in a while. Have they audited you yet?

Douglass:No, but I'm looking forward to it.

Lapera:Our company lawyers are fearsome, and I was terrified that I had forgotten to do every single step the last time I got audited.

Douglass:But everything turned out well.

Lapera:Everything was fine. It'srandom audits, they weren't suspicious of me.

Douglass: That'sgood. Let's hop in. We're talking about two socks today. Todd'sgoing to be pitchingIllumina,I'm going to be pitching Gilead. These stocks are basicallytwo vastly different stories, but I'm sure we'll get more into that in a minute. Todd, why don't you go aheadand start us off?

Campbell: First of all, Gaby,I think this is a phenomenal idea for a show. And it's perfectly timed. It'salmost like the Super Bowl of stocks. Too soon for the non-Patriot fans among you?

Douglass: Gaby is saying "uh" because,Gilead reported earnings yesterday,and I have been counting down toward it,sort of like some people count down toward the Super Bowl. Several colleaguesinternally, including Gaby,have been rolling their eyes at me. Anyway,that's neither here nor there. Illumina, go ahead.

Campbell: [laughs] All right. Gaby,I didn't do this for you,this is not specific advice for you. But, withhundreds of stocks to choose from,I had to set some sort of ground rules formyself, and coming up with an ideathat I wanted to talk about today. So,what I did is I created in my head ahypothetical investor. Andthat hypothetical investoris someone who is maybe in their twenties,thirties, early forties. They have a 10-30 year timehorizon for investing in the market. They'redoing everything they should be doingas far as putting aside their income,10% or more every year. Andthey want to also own individual stocksin a diversified portfolio that includes healthcare. So, that was step one: what would fit thathypothetical investor well?

Thethe second thing was, if I'm going to narrow down the list further,what is it about some of the greatest,best-returning, most revolutionary companies of the last 10 to 20 years? What common thread do they have? That wouldinclude stocks likeAmazon, Google, Netflix, Priceline, truly disruptive companies that reshaped industries and quicklybecame leaders within their field. And that one common thread that they all shareis that they put innovation first. They're innovation first companies. Their goal is, consistently, disrupt, disrupt, disrupt. They arefar less worried about what happens in one quarter to the next quarter to the next. They are looking long term, they'replaying the long game.

So, when I thought about healthcare with that backdrop, the name that jumped to the forefront was Illumina. AndI'll talk about why in a second, but I thought it might be fun firstto play a quick game.

Lapera:OK,I'm ready.

Campbell: OK. Michael, are you ready?

Douglass: Sure.

Campbell: Over or under -- are there over or under 50 million Baby Boomers in America?

Lapera:Over.

Douglass: Yeah.

Campbell: Yes. 76 millionBaby Boomers. And guess what -- they're all living longer lives. So,we have this huge aging patient population inAmerica. Next one, over or under -- there are over or under five billion people in the world?

Lapera: Over.

Douglass: Over.

Campbell: 7.5 billion peopleliving in the world today. And there were 15 million people beingbornso far this year alone. So,in the first month and a couple weeks,15 million new births. Whatdo you think the global life expectancy is going to do, forall of these people over the course of the next 10-30 years? Is itgoing to get shorter, or is it going to get longer?

Douglass: Longer.

Lapera:Longer. Probably.

Campbell: Absolutely. So,we have this huge patient population that is growing and living longer. Andthat's going to create a tremendous amount of demand across the healthcare industry. That's one of the reasons that I feelthat healthcare stocks should be partof a diversified portfolio. So now, let's get into why I like Illumina. I mentioned that I liked innovation-first companies. Well, Illumina is now being run by a guy namedFrancis deSouza. AndFrancis, in his most recentconference call with investors, said, "At our core,and this has been true since the founding of the company,we are an innovation-driven companyand we spend a lot of time thinking about the fundamental breakthroughs that will acceleratethe adoption of genomics, andaccelerate,as in our mission to improve, human health throughunlocking the power of the genome." Andthe way that he and this company are going to do that is bydeveloping increasingly more powerful genetic sequencing machines. They are going to allow researchers and drug developers to divedeeper and deeper and deeper into the understanding ofhow our bodies work. Andin doing that, they're going to be able to unlockdiscoveries that will lead to newmedicines that more accurately can treat individuals, and that can transform outcomes. And that is at the crux of why I like Illumina as a long-term investment. They are the Goliath, the Amazon, of theirindustry n making genetic sequencing machines. They have more than 7,500 of these machinesdeployed throughout the world. And they just rolled out new machines this year -- the NovaSeq 5000 and NovaSeq 6000. Thesemachines are faster, they're better, and they'relikely to spark a major overhaul of all of those thousands of machinesthat are already deployedthroughout the world. I think that could kick-start asignificant amount of demand, andunleash a lot of genetic research thatotherwise has not beenconducted today because of its expense.

And the reason behind that --I'm getting long-winded -- is that these machines put in place apathway to reduce the cost of sequencing a genome from $1,000 today toeventually as little as $100. Toput that in perspective, in 2010,it cost $10,000 tosequence genomes. So, as this price falls, we'relikely to see far more research getting done,and that's likely to drive demand for the consumables that are used by these machines.

Lapera:OK.

Douglass: All right.

Lapera:I have so many questions for that, but we're going to reserve the Q&A until later.

Douglass: All right. Very good. Thank you, Todd. Let me give abrief pitch for Gilead Sciences. Gilead Sciences is a stock that isprimarily in two businesses today:treating HIV and curing hepatitis C. It is the market share leader in both. So,it's kind of the big dog in both of theseenormous markets. Now,usually, it's kind of hard for people to recommend to stock that is down 10% the day that they'rerecommending it, after guiding for its 2017 to fall by over 20% at the midpoint from its 2016 numbers.But I think that Gilead Sciences has anunderappreciated and enormous opportunity. So,let's talk about it.

Hepatitis C, they are curing patients. Unlike with HIV, where, once you have HIV, you pretty much have it for life, and there are treatments designed to manage the disease, withhepatitis C, these are cures. We're talking 95-99% cure rates forhepatitis C. So, when itonboards a patient, it cures that patient, and that patientfalls out of the revenue cycle for Gileadbecause they no longer have hepatitis C. So,hepatitis C revenue is on the decline,and that's because they have basicallytreated the sickest patients,so they are now increasingly treating less sick patientswho need less medicine to get better, to be cured, and who are also less urgently in need, so they areseeking treatment at a slower rate. So, that is going to drag on the company's top line, for sure, andthat's why they are guiding for the revenue to fall so much next year. HIV issupposed to be stable to maybe a little bit up.

Now, I think the keypart of the thesis for Gilead isoptionality. That stems from two things. First off, they have a superb management, with a fantastic history of accretiveacquisitions, and I'll talk briefly about a couple of them. When they boughtTrianglePharmaceuticalsin 2003 andPharmassetin 2012, inboth cases, there was a lot of speculation by analysts that they overpaid. Triangle provided an HIV drug calledemtricitabine, which is a big part of Gilead's HIV franchise. Pharmasset providedsofosbuvir,which is a big part of Gilead's hepatitis Cfranchise. In both cases, they made several multiples ofwhat those acquisitions cost them pretty quickly. Gilead has a management that is really good at allocating capital. And that, I think, is one of the key differentiators in healthcare and any industry -- if you have a management who really knows what they're doing,they can make really good things happen.

Thesecond piece of optionality that Gilead has is,it has a ton of cash. Thehepatitis C franchise might be on the decline,but it is a cash cow. We're talking 88-90% gross margins on their drugs, so there's a lot of cash that they have sitting, about $32 billion. Andmanagement has said that theirprimary focus in 2017, I'm quoting CFORobin Washington here, "Leveraging our capital topursue external opportunities to expand our R&D pipeline." What that means is M&A. Now, Gilead, with all that cash, can buy a lot in healthcare. There are a lot of healthcare companies that it could do a tie-up with. So, what'll beinteresting, of course, iswhether they maintain that discipline. Thefact that they have maintained that discipline,even though they are guiding for theirrevenue to decline this next year, andeven though Wall Street has been pushing them to buy somebody already for over a year, really speaks, I think, to management's confidence in its own ability. The second thing is, frankly, with that $32 billion in cash, their market cap is in the upper $80 billions, they could, right now, retire over a third of their shares outstanding at current prices,because they're trading at about 6.5X earnings. So, where Illumina is very much a growth play, I think Gilead is very much a valuation play, and I think it is an incredibly attractive company at these prices, even with the declines built in for next year. And especially given what it can do with that cash, and with the superb management team.

All right. The Q&A. Gaby, fire away!

Lapera: OK. Myfirst question is actually for Todd,because I am very interested in genomics. I might ask you some questions thatthrow you for a loop, because I don't know if you know thisabout me, talking about books that we read in our spare time,I really enjoy genetics a lot. [laughs] So,my first question for you is,do you know anything about epigenetics? Let's start there.

Campbell: I know it's a major area of research,and a lot of money has been put forth in research into it.Celgenehas some stakes,and a couple different companies are doing some work on it,but I haven't taken a look at it recently.

Lapera: OK. That wasactually going to be my first question. Epigenetics is kind of ...we should do a show on epigenetics, Michael. We'll forget Kristine. [laughs]

Campbell: We'll ask Kristine what she would like to do, and you two can sort that out. I am filling in today.

Lapera: But,I'm really interested to know, does Illumina have any plans to do anything with epigenetics? Becauseepigenetics also requires a type of sequencing,and it's becoming more and more important,especially as we realize the effect that epigenetics has ondisease outcomes for individuals. Is there any future for that? Or is this just mewildly speculating?

Campbell: Here's the thing --the whole concept is to figure outhow we can sequence not only the body, but also sequence tumor cells, to learn more about tumors so that we can better attack them. So, there's atremendous amount of research that's going on through drug companies throughout the worldto try and evaluate the DNA and RNA that isresponsible for disease. Andnot justgenetic disease like Down syndromeor something like that. It's also cancer. And I think you're going to see more,not less, of that activity going on. I mean, you have China spending $9 billion on its ownprecision medicineinitiative. You have the U.S. spendingbillions of dollars on ours. Europe is doingprograms like this as well. Andthe whole idea behind it is to learn more about our bodies and diseaseso that we can better target therapies to it. Andit doesn't matter where,if it has to do with genetics, they'regoing to beusing machines like Illumina's. And Illumina is the biggest player. It's like theCoca-Cola(NYSE: KO) of this industry. So,my feeling is, if you believe that epigenetics is the future,and research is going to be done on genesand these gene discoveries are going to be delivered by machines like this, then Illumina is a stock to buy.

Lapera: OK. NowI have a few more questions based on my time spent in labs. What's thelife cycle intended for these products? BecauseI have totally worked in labs wherethey are using the same machinery that they have had since '95, like,you need a Windows 95 compatible computer to run these machines. Is that going to be a problem?

Campbell: These are all next generation stuff. Thelife cycle is measured in years, not decades. The last major launch was about five or six years ago, the HiSeq X Ten. When that came out, that's whatdropped the cost of sequencing the genome from$10,000 to about $1,000. Obviously, the NovaSeq that'scoming out this year is probably going to have a five to eight year lenght,something like that. The transition to these machineswon't happen overnight. It'll be a slow,as you would imagine, roll out. Aspeople bring these machines in,they get comfortable, and they shut down the use of the older machines. But,I think that creates an opportunity where, if revenue slowsa little bit this year,then it could reaccelerate as we get into '18, '19, and '20, as more and more ofthese machines get swapped out for these machines, andresearchers to get more comfortable using them.

Lapera: Yeah. That'sinteresting. Most of my experience with research has been in grant-funded labs,as opposed to commercial labs. So, there,it's a matter of,do we have the money to buy a new machine? No? Then we'resticking with the one that's 25 years old.

Campbell: Yeah,and I think that what you're going to find is,there are more and more waysto be able to leverage of the technologyand the discoveries by those researchersusing these grants. That's one of the reasons, too, thatso much money is being contributed now by the NIH and grants to things like theprecision medicine initiative to do genesequencing, specifically calling out, this is a major area for funding.

Lapera: Cool. Thank you very much. Do you have any questions for Todd about Illumina?

Douglass: No,I don't think I do.

Lapera: OK, well,I am ready to ask you some questions about Gilead.

Douglass: Shoot.

Lapera: We know thatGilead is in the HIV and hepatitis C space. What would they be looking to expand into? Would they continue into HIV, or ... ?

Douglass: Greatquestion. Company managementis always a little hesitant about tipping their hand too much. But, what Gilead's managementand has shared is that they are looking to expand into cancer and intoautoimmune diseases. Agreat example of this was, Gilead basically purchased the rights to a drug calledfilgotinib from a biotech calledGalapagoslast year. Andfilgotinibis an autoimmunedisease drugpotentially,and they got it for a good price. And it looks like, if the clinical trials continue to show positive data, and if it grows into the marketing expectations, the peak salesexpectations that analysts have guided for, that it could be worthquite a bit more than they paid for it. So, that's just classically Gilead,to find something that people think they know the opportunity with and find a greater opportunity with it. So, yeah, it looks like they're thinking more along the autoimmune and cancer lines. That said,they actually have a couple of cardiovascular drugs,which they basically purchased because they were off the shelf ready to go. So, it didn'trequire a lot of investment by them to make it happen.Management has also said that they would be willing to get some off the shelf stuff that's outside theircore areas of competence, if you pay up front and it just goes. So, I think we could see either way. But I think it'smore likely that we'll see more autoimmune and cancer.

Lapera: Interesting. Does Gilead do mainly purchases, and thena little bit of in-house tinkering? Ordoes it have a really big in-house R&D department as well?

Douglass: They do have a big in-house R&D department,and a lot of their drugs are internally sourced. That said, they do apretty good job of alsofinding external drugs. I wouldcharacterize management's philosophy as, "Wherever we can get the best ROI on our time and money, we will do it." So, they've done a good job on both ends.

Lapera: This is my out-there question for you: do you thinkGilead will kill hepatitis C? Well,Gilead and all the other drug companies that have hep C drugs.

Douglass: To be clear, there are a couple of othercompetitors, primarilyMerckandAbbVie. They haverelatively low market share, we're talking about, when last shared, Gilead's market share was in the mid 80s. So, they're the big dog in the space.I think it's going to be a very long timebefore hepatitis C is completely gone. And that'sbecause it's relatively easy,comparatively easy,for somebody to get hepatitis C treatment here in the United States or in Europe. It'sgoing to be a lot harder in Nigeria or somewhere else where thereisn't an enormous healthcare system. I do believe that hepatitis C can bepretty close to wiped out, but it's not going to be a next year, or even -- I think, andI'm totally speculating here -- next decade kind of thing.

Lapera: That'stotally fair. I mean, we technically still have leprosy. And bytechnically, I mean we definitely do. Don't pick up armadillos,they are the primary vector of infection in the United States forleprosy. Fun fact! I'm well known around The Fool for my not-so-fun facts, unfortunately. [laughs]

Douglass: They are always something. [laughs]

Lapera: Todd,do you have any questions for Michael?

Campbell: Oh,so many questions, but I know we're a little bit tight on time. And I know that Michael probably has some questions about Illumina, too,and he's just being kind. I would just say toall of our listeners, we have tons of content on this on The Fool website, so if they have any questions thatthey're not getting answered by us,please go there.I think Michael did a great job inexplaining the backstory and the reason to buy this one.

Lapera: Everyone has beenso polite, it's incredible. I thought you all would bereally cutthroat, and everyone's like, "No, it's wonderful!"

Douglass: Well, Todd and I are old friends, we'veworked together for a while now. And Todd, I'll also say,I thought that was a very good high level on healthcare and Illumina's opportunity. Folks,if you do have aspecific question and you want an answer,shoot us an email at industryfocus@fool.com.I guarantee we will respond. We love listener emails. In fact, a couple weeks ago, Dylan Lewis brought beback for an encore episodebecause a listener emailed in and had a question, and we were like, "Cool, we'll do a whole episode based on that." Now,I'm not guaranteeing an episode here,but we will get you an answer. We'repassionate about stocks,it's just kind of what we do. So, that's big for us.

Lapera: Yeah.I actually do have one more question for both of you, which I've asked everyone else so far. If you could give one piece of advice to a beginninginvestor, what would it be?

Douglass: For me, the big one would be, when you're new to a sector, go big. By that,what I mean is, healthcare, energy,a lot of these sectors are really kind of difficult to get your feet wet in, and it's great to start with a big cat company. Do not go for some $200 million clinical stage biotech before you really understand the overall disease treatment sphere. Big companies are really great for that. They tend to be welldiversified,they tend to have a lot of different products. So,you can get a sense of a bunch of different markets. Plus, if you're wrong in your investing thesis, chances are good the company's not going to go out of business. When you pick the really small ones, they could just die, whereas aJ&J, aCVS, a Gilead or an Illumina, probably going to be around a few years from now, barring something really crazy happening.

Lapera: Todd?

Campbell: Diversify. Diversify,diversify, diversify. Kristine and Italk about this every week on the show,especially when you're dealing with healthcareandbiotechnology stocks, biopharma, make sure that you don't putall those eggs in one basket. Spread it around a little bit, becausethere are things that cause stumbles and 10% drops in one day, and you need to be able to ride that out across an entire portfolio.

Lapera: Thank you. Those are twovery good pieces of advice, andI think we have had a very thoughtful and substantial conversation, as I've had the last two days.

Douglass: Well, good, fantastic. Well, Gaby,thanks for joining us on Industry Focus: Healthcare. I'm also glad to have gotten to hop in for a bit, and Todd, as always,thanks for everything you're doing. As always, remember,contributors on the show may own stocks we discuss,and The Motley Fool may have recommendations for or against stocks that we're discussing, so please do not buy or sell or really do anything with a stock based solely on what you hear. Alwaysdo your own due diligence. It's the right way, it's the Foolish way. ForTodd Campbell and Gaby Lapera,I'm Michael Douglass, thanks much and Fool on!

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Gaby Lapera has no position in any stocks mentioned. Michael Douglass owns shares of Alphabet (C shares), Amazon, Celgene, Gilead Sciences, Johnson and Johnson, and Priceline Group. Todd Campbell owns shares of Amazon, Celgene, and Gilead Sciences. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Celgene, Gilead Sciences, Illumina, Netflix, and Priceline Group. The Motley Fool recommends Coca-Cola, CVS Health, and Johnson and Johnson. The Motley Fool has a disclosure policy.