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...
Pity investors in Gilead Sciences (NASDAQ: GILD). They just cannot seem to catch a break.
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After six straight quarters of year-over-year sales declines at its marquee hepatitis C (HCV) treatment business, Gilead stock has been left for dead -- its share price basically flat over the past 12 months despite the rest of the S&P 500 surging ahead 19%. Even a pop at the end of August -- inspired by the company opening its wallet to buy fast-growing cell therapy biotech Kite Pharma -- proved short-lived, and Gilead stock today trades right back where it did before announcing its big acquisition.
And yet, hope springs eternal for investors who believe that Gilead may be that rarest of birds: a bargain in the biotech sector. This morning, StreetInsider.com (requires subscription) reported that biotech specialist Maxim Group is upgrading Gilead stock to buy. Assigning the $74 stock a $94 price target, Maxim argues that in "buying GILD now you [get] recently acquired KITE for free."
And this isn't exactly a novel idea...
An obsession with "free"
When analysts talk about Gilead, they're kind of obsessed with the "buy one, get one free" (BOGO) argument. In February 2016, value investor Vitaliy Katsenelson wrote on Contrarian Edge that, at a then-current stock price near $90 a share, investors in Gilead could buy the company's HCV business "and get HIV for free." Crunching the numbers, Katsenelson argued that HCV treatment sales by Gilead are likely to "generate more than $140 billion in aftertax profits over the next decade." (The company had earned $18.1 billion the year before, and would go on to earn $13.5 billion in 2016.)
Even with profits declining (Gilead has earned only $8.5 billion so far this year, according to data from S&P Global Market Intelligence), Katsenelson estimated that this division alone justified a share price of $100 for Gilead, and "HIV and other drugs" were on track to sell enough to add another $45 or $50 in share value.
Hence, at a stock price of $90, Gilead's HCV business was selling at a discount -- and its HIV business was "free."
A long obsession
Ten months later, Gilead's stock price had fallen into the $70s. The HIV business was doing even better than expected, prompting Katsenelson to switch lenses and argue that $70 a share was a fair price to pay for Gilead's "HIV and other drugs" -- and it was the HCV business that was on sale.
Citing $4.50 per share in earnings from the non-HCV side of the business, "8-10%" revenue growth ... with very high recurrence of revenue" and "substantial operational leverage" on that revenue, Katsenelson concluded that Gilead's HIV business was now worth closer to "$67 to $76" per share.
At a $70-ish stock price, that meant the HIV business was now fairly priced, and the monster cash producer that is HCV treatment had become a BOGO.
Which brings us to today
According to Katsenelson, regardless of which part of Gilead you buy, you get another part "free." Now comes Maxim Group to add a third option -- buying both parts of the original Gilead Sciences, and getting its new Kite division for free. The argument has merit.
After all, Gilead stock was selling for about $70 up until just a few months ago, when Gilead announced its acquisition of fast-growing Kite Pharmaceuticals at the end of August. That deal immediately added $10 a share to Gilead's stock price, rocketing the stock up 13% through the first week of September. Since then, however, Gilead stock has given back all of its gains from the Kite news. It still owns Kite, but Kite, its axi-cel CD19 therapy, and all the other drugs that might come out of Gilead's new cell therapy unit in the years to come -- that's all "free" now.
Everybody loves a BOGO offer, and both Katsenelson and Maxim seem pretty convinced there are BOGO offers aplenty at Gilead Sciences, differing only on which division is being given away for "free" on any given day. But even with the freebies, is Gilead stock a good bargain?
As Maxim points out, Gilead generated "~$2.7B in free cash flow last quarter" (and about $8.8 billion year to date). And this was before any benefits from the Kite acquisition might be felt. Maxim argues: "We are now seeing a paradigm shift in oncology with T cell therapies integrating into treatment regimens for years to come, CD19 is just the beginning."
Already, the rate of profit declines from Gilead's HCV business appears to be moderating. Assuming free cash flow stabilizes in the neighborhood of $10 billion, Gilead, at $96 billion in market cap with essentially no debt, already looks like a pretty nice bargain to me.
What's more, with Kite in the mix, there's now a strong possibility we could see Gilead's profits begin growing again in the not-too-distant future. Indeed, analysts surveyed by S&P Global predict profits will bottom out next year, grow 4% in 2019, and then rapidly ramp up to grow a further 32% over the succeeding two years.
At a 10 times free cash flow valuation, with growth rates in the 15%-annualized range soon to be expected, I agree with Maxim on this one: Gilead Sciences stock is a buy.
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