Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
Since Gilead Sciences (NASDAQ: GILD) announced its plan to buy Kite Pharma (NASDAQ: KITE) for $11.9 billion on Monday, Gilead stock has enjoyed a big 12% bounce -- but analyst reaction has been mixed.
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R.W. Baird quickly came out with a note highlighting the risks of Gilead competing in the cancer sphere, where Novartis just notched a victory with FDA approval of its CAR-T gene therapy. Given the competitive threats, Baird dismissed Gilead's move into oncology as "incrementally negative" for the stock. Mizuho Securities did a quick straw poll of investors and concluded that "60% of respondents believe Gilead overpaid for Kite," while Credit Suisse begged to differ, raising its price target for the biotech's stock.
Now, with shares up 12% since the deal was announced, sentiment seems to be swinging even further in Gilead's favor. Here are three things you need to know about that.
1. Two upgrades today
First, the headline news: Two Wall Street analysts blessed Gilead with the equivalent of buy ratings this morning. William Blair initiated coverage of the stock with an outperform rating. Argus Research, which was already covering the stock with a hold rating, upgraded Gilead to buy and assigned a new price target of $100.
With Gilead stock selling for about $80 at the time the upgrade came out, that means Argus is looking for a 25% profit on Gilead stock -- on top of the stock's 2.8% annual dividend yield.
2. Why Argus loves Gilead
What makes Argus so optimistic about a stock most of Wall Street was panning earlier in the week?
As StreetInsider.com (subscription required) explains, with Kite in hand, Argus thinks Gilead "will gain a leading-edge cell therapy technology and a new oncology drug that appears on track for approval by late November. It will also acquire a platform for developing new oncology treatments for blood cancers and solid tumors" -- permitting the development of new drugs (and the growth of new profits) down the line.
That prospect for a rapid return on Gilead's investment, when Kite's axi-cel cancer treatment (maybe) goes to market, is one reason Argus is rushing to recommend this stock.
3. Gilead becomes a triple threat
Axi-cel may or may not win FDA approval. If it does, it will do more than just expand the company's pipeline -- it will transform Gilead into a triple threat in healthcare. Gilead's major revenue streams will come from:
- HIV/AIDS treatment (currently $12.9 billion, or 43% of annual sales),
- hepatitis C (HCV) treatment ($14.8 billion, or nearly 50% of sales),
- plus whatever axi-cel and its derivatives produce.
This will diversify the company's revenue streams across three very different product lines, and help to stabilize Gilead Sciences' business by decreasing its overreliance on its current flagship -- but declining -- HCV business.
Granted, it will take time to build out the axi-cel oncology business even after FDA approval is received. But as Argus points out, Gilead generates very strong free cash flow from its existing HIV and HCV lines of products. They may not be growing much right now (indeed, profits are down nearly 50% over the past two years, and analysts expect earnings from these businesses to decline further). But they're still producing some cash, and certainly enough to keep Gilead going while it spins up an oncology franchise.
Valuing Gilead Sciences stock
With $12.2 billion in trailing-12-month earnings, and $13.4 billion in trailing free cash flow, Gilead Sciences remains a very profitable stock. Valuation-wise, Gilead stock costs 8.7 times earnings, but only 7.9 times free cash flow (FCF).
That said, it's hard for value investors to call the stock a bargain when analysts continually harp on the fact that Gilead's profits are declining, not growing. (Traditional PEG ratio valuations and even fancier valuations based on enterprise value-to-FCF-to-growth all depend on a company growing at a certain rate -- not shrinking.)
Thus, the best news of all for Gilead today is that, by buying a growing business like Kite, where sales are expected to explode from less than $100 million today to more than $1.4 billion over the next four years, Gilead may finally win back for itself a positive growth rate -- and give value investors an excuse to buy it again.
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