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How Gilead Sciences Can Deliver A Double: Part Two

This article is more than 9 years old.

Last month, Eugene Groysman made the case that Gilead Sciences (NASDAQ:GILD) can double its stock price because of high demand for its new Hepatitis-C drug, Sovaldi, even though it costs $84,000 per treatment. Eugene has an exceptional long-term investment track record so when he tells me how a stock can double I pay attention, and then I verify.

You can view Eugene ‘s top five holdings, learn more about his strategy, and track his progress with monthly Performance Insights emailed directly to you at the end of each month by visiting our website.

When I research stocks, the opinions I value most highly come from those who have taken a position in the stock and have made money on it. After all, if the person expressing an opinion about the stock does not have a strong enough conviction to make a trade on it, why should we? And, if they have made trades on the stock, but have not made any money, why should we follow their lead?

Gilead Sciences' is one of Eugene's top 5 holdings. (Photo credit: bigstockphoto)

Results matter, which is why we polled our investment research community about Gilead Sciences. The members who shared their investment insights with us for this article are those who have put their money where their mouth is, as the saying goes. They have acted on their stock insights. Of the comments I received from our members about Gilead, four particular opinions stand out to me as particularly worthy of note. These members have long-term records of accomplishment with Marketocracy and a history of making money on the stock to validate their opinions. We even heard from Marketocracy Master Mike Koza about the topic.

Track Mike Koza’s monthly performance insights here as well.

The data provides clear reasons why I wanted to reach out to our elite membership. Nearly 59% of the positions of Gilead held by our membership are in the portfolios of our top quartile members. Almost 89% of the net positions added are from our elite m100 members. Clearly, the smart players are adding to their positions in Gilead, and the data proves that.

Given Eugene’s central thesis that Sovaldi will be the catalyst for Gilead’s stock price doubling in the next 3-5 years, we asked our membership about the new drug’s impact.

Brendan O’Boyle, who works in the pharmaceutical industry, and whose track record is a robust 51.03% since he started in May 2013, had the following to say about Gilead:

Sovaldi is already a huge driver in Gilead's sales. The drug already accounts for 45% of revenues and is the most successful drug launch ever. While this is widely known and thus discounted into the market, what is less widely known is the size of the potential market outside of the United States. At present, international sales account for 25% of Gilead's revenues. So far, Sovaldi has only been approved for use by the FDA, with further applications soon to be considered in the European Union. To realize the size of this growth potential, consider that according to the CDC 3.2 million Americans are infected while there are 130 million chronic infections worldwide. Even a casual glance at Gilead's growth indicates that the 45% of Gilead's revenue belonging to Sovaldi has ample room to grow.

Over the next year, I expect Gilead's earnings to rise from $4.94/share to $6.32/share, a growth rate of 28%. However, in the most recent quarter the United States rollout of Sovaldi contributed to a doubling of revenue. Since applications in the EU are coming soon, the street's anticipated earnings for Gilead are still likely too low and further upside surprises are likely.

So why did Brendan add Gilead to his portfolio?

My rationale for including Gilead in my portfolio was due to expectations for Gilead's growth that were too low, combined with an extremely attractive valuation. Even at the present price of $87/share (which is far higher than my fund's cost basis), Gilead trades for only 17x forward earnings, which I already believe may be understated. Because of this, I believe that Gilead Sciences can achieve a double in the next 3-5 years by doubling revenues given its already attractive valuation. Simply, the European Union rollout should be sufficient to accomplish this.

So what are the risks Brendan sees for Gilead?

While I believe Gilead is a good investment opportunity there are still considerable risks. First, Sovaldi is incredibly expensive at $84,000 per treatment. Insurance companies have already pushed back on that price led by Express Scripts and treatment of all patients who should be in the patient population is far from guaranteed. The good news is that the plague of Hepatitis is even more expensive, with liver transplants as part of the standard plan of care, costing millions of dollars over time. This is a substantial motivator on economic terms for the drug. The second major risk factor is competition. Merck recently purchased Idenix for a purchase price of $3.2 billion, primarily for their Hepatitis pipeline. While Merck may be years away from a viable competitor, this is risk that should not be ignored. The third risk factor for Gilead is that Sovaldi is so effective that a course of treatment represents a cure for the disease. Because Hepatitis was previously a chronic infection, sales of Sovaldi may not have the same growth trajectory that some pharmaceutical releases like Prozac or Lipitor have enjoyed because patients ultimately do not stay on the drug long-term. However, as outlined above, the remaining market is still huge, but this is a risk factor, which may ultimately slow Gilead's revenue growth in the years to come.

What is interesting about Brendan’s risk analysis is that Sovaldi’s effectiveness creates its own risks because it actually works. Mike Koza had the same thoughts, “It is acting like Apple, because it’s big, but still has great growth numbers. The drugs are so good; they might even run out of patients. I doubt that will happen, though, because once people know there is a drug that works, they will take more risks. When that happens, they will still need their drugs.”

I think both Brendan and Mike make a key point here. There is a huge demand for Hepatitis treatments. And finally, Gilead Sciences has developed a drug that will effectively treat the millions of people suffering with this disease. It is a simple concept; when there is a demand for a product, and no better alternative exists, then a company is able to control the price points for its products. Gilead is no different and will benefit from this over the next few years.

Thomas Pound, who uses a quantitative analysis approach, added his opinion. The track record for his healthcare fund is an annualized 11.2% since August 3, 2003 compared to the MSCI World Health Care Index of 9.7% over the same period.

The Gilead story was already strong without Sovaldi. The new drug only makes it stronger as it is the only drug protocol available for Hepatitis-C. The current target price I calculated for Gilead  is $101.46 with a 16% margin of safety. Without Sovaldi, it is probably reasonably priced. That is why Sovaldi is so important to taking the company to the next level. In terms of its financial health, it has an Altman-Z score over eight, so it is financially strong.

What does Thomas see as the potential risks?

The risks are mostly political. We are in an environment where insurance companies, with political backing, do not want to pay for treatments, even if those treatments work, and are what patients need. My wife, who is a doctor, has some insight with this. Healthcare providers are in a constant battle with insurance companies over payments, and the insurance companies are pushing back, because the political winds seem to blow in their favor. The politicians want first rate healthcare, but they don’t want the consumers, especially through the insurance companies, to pay for the goods and services.

Again, Mike Koza added his insight to the political risks for Gilead.

The politicians like to beat on it, so there is a risk there. Henry Waxman has created some real problems and did hurt companies like Gilead and Questcor. However, the politicians did create a buying opportunity when that happened, so I did. Express Scripts (NASDAQ:  ESRX) is also pressuring Gilead, but all of these things create buying opportunities. They are trying to change the playing field, but what they are really doing is complaining that the drug is so good.

Richard Hawkins, whose recent fund has experienced a 64.68% return since December, added his thoughts about owning Gilead.

Sovaldi will be a major contributor to near term sales and earnings. However, GILD already has 75% of the HCV market, so the ability to grow market share will be severely limited. Also as patients are treated and hopefully cured, the total patient population will actually shrink over time.

So why did Richard buy Gilead?

Gilead’s R&D focused management has an excellent track record of bringing best in class treatments to market, making good capital allocation decisions, and acting in a shareholder friendly manner, so it always is a good potential portfolio candidate.

A possible macro catalyst is that I believe there is a looming bond market meltdown of major proportions over the next 12-18 months. This will drive a flight to equities, in particular, defensive healthcare stocks with wide moats like GILD. Given this, my current calculation of a likely price in a couple of years is $125 per share. The obvious risk for all of this is competition (or litigation) from similar treatments from AbbVie (NYSE:  ABBV), Bristol-Myers Squibb (NYSE: BMY), and Merck (NYSE: MRK).

Since two of our Marketocracy Masters own Gilead, and we have already heard extensively from Eugene, we will finish this conversation by seeing what Mike Koza says.

Sovaldi will dictate Gilead's performance until Gilead produces another blockbuster. With its mushrooming cash flow and sharp eye, Gilead could buy another wonder drug just as they did with Sovaldi.

So what does Mike think will happen over the next few years?

The forward P/E based on 2015 EPS was under 10 when I bought. Growth stocks with P/Es less than 10 are usually a slam dunk to beat the market. Gilead doesn't have to do anything spectacular to double in 3-5 years. All they have to do is not let the US Congress or self-interested pharmacy benefit managers tell them what to do. Express Scripts (NASDAQ:  ESRX) is really pressuring companies like Gilead. Stabilized earnings growth of approximately 11% should warrant a P/E of at least 18, which would translate to a target price of $142 (coincidentally the highest analyst target price) right now. Adding 11% per year would see a double within 3 years. I might sell if it reaches $100.  I usually hold a stock for about a year, but with this company, it’s going to depend on how the revenues and earnings perform during the next year.

Mike agrees with Richard that competition is always a risk factor. The risk factor here is that somebody comes along with a better Hepatitis drug. However, right now that is not happening.

What is important about these price targets is that all are more than 15% above Gilead’s current price. If a company’s stock price is able to grow 15% in a year, then it will double in about five years. That is our goal at Marketocracy. We seek to find stocks that have the ability to double in 3-5 years.

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Disclosure: I am the portfolio manager for mutual and hedge funds advised by Marketocracy Capital Management, an SEC registered investment advisor. Before relying on the opinions expressed in this article, you should assume that Marketocracy, its affiliates, clients, and I have material financial interests in these stocks and may hold or trade them contrary to these opinions when, in our view, market conditions change.