The essence of value investing is in buying things which are out of favour. When these things decline further in price, we get excited and buy more. It is for this reason that I don’t place stops on any of my un-leveraged positions, and as it stands, Gilead Sciences is a case in point.
I first bought $GILD in August of 2016, based on the usual criteria that are important to me. High levels of free cash flow generation, high returns on investment and attractive valuation metrics.
Gilead had enjoyed a nice run up of around 476% between the beginning of 2012 and mid 2015, before entering into a decline of -32.4% at the time of my purchase. Mirroring this, growth in financial performance was impressive with five year revenue growth compounding at 32.64% a year, and net income growth even better at 44.23%. This growth has since tailed off, with revenues and net income declining somewhat since the 2015 peak.
Gilead Sciences are one of the largest biotech companies in the US, with revenues are derived from sales of patented products to the pharmaceutical industry. The company have been at the forefront of development into products used in the treatment of HIV, as well as chronic hepatitis-C (HCV), and hepatitis-B (HBV). The below chart shows the proportion of revenue derived from these products:
Fair to say that HIV and hepatitis related products produce the bulk of revenues generated by the company. As you can see, the revenue fall-off of these particular products are what have led the decline in overall profits for the company, which is likely to continue as patients complete their treatment regimes.
Why I’m Holding
$GILD has been a fairly poor holding this past year. The share price had continued the steady decline that had already begun at time of purchase, and revenues are declining. I was at one point down over -20% from my initial position. A stop loss would likely have had me out of this. All told, not much to be optimistic about.
However, as of this past two weeks I am now back to being marginally in profit due to a fairly large upward movement beginning in mid-June. The company maintains robust free cash flow generation through the strong operating margins it commands from its products, and derives high returns on invested capital. Comparing this with Gilead’s competitors reveal just how profitable the business has been in previous years.
Due to the strong levels of free cash flow generation Gilead had also built up a fairly substantial cash holding, which at the end of the 2016 fiscal year stood at $32bn. The company had been facing growing discontent in some areas for not making effective use of this cash, despite initiating a buyback program which has bought back nearly 22% of outstanding common stock since 2013.
Management have however been fairly astute in their deployment of capital, with their last major acquisition in 2011 of Pharmasset for $11bn. It was this purchase which gave them access to the two major hepatitis drugs, Harvoni and Sovaldi, which have driven the large capital returns of the last few years.
Gilead opened the war chest again at the end of August to fund the $11bn purchase of Kite Pharma, one of the leading companies focused on the development of cancer immunotherapy treatment. Kite’s particular research has been on a form of treatment called CAR-T, using the bodies own immune system to attack cancer cells. The process involves removing cells from the body, re-engineering them, and adding them back to the body. A similar form of immunotherapy treatment engineered by Novartis was given FDA approval in July, and Kite are waiting on a decision on CAR-T in November.
Initial trial data appears compelling:
There is potential for this therapy treatment to become transformative for Kite, and by extension Gilead, hence their decision to target the acquisition now rather than wait until FDA approval is granted (assuming it is granted).
I am of course cognizant of the fact that there is a large element of speculation in this at present, which is unlikely to be resolved at least until FDA approval is achieved. I remain confident however that the management at Gilead have done their due diligence. Their last acquisition was transformative for the company, and there is strong speculation that discussions with Kite Pharma began all the way back in 2015. Clearly they have had their eye on Kite, and CAR-T for some time.
Finally, Gilead’s valuation at present is compelling, particularly against competitors:
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Disclosure: GILD is a constituent of the portfolio.