Gilead Sciences Pipeline Remains Undervalued

December 3, 2012 by William P. Meyers

Gilead Sciences (GILD), has had a good year so far. On January 3, 2012 it opened at $41.46. Today it closed at 74.61, fairly near its 52-week high of $76.28. So up 84% this year. I used to write about Gilead more often during the years 2007 to 2011, arguing that it was undervalued. After finally getting a solid run up, is it time to bail out, hold, or buy more?

The forward-looking story is now largely about curing Hepatitis C, but first the latest backward-looking numbers.

In Q3 revenue was $2.43 billion, up 1% sequentially from $2.41 billion and up 14% from $2.12 billion in the year-earlier quarter. GAAP net income was $675.5 million, down 5% sequentially from $711.6 million, and down 9% from $741.1 million year-earlier. GAAP earnings per share (EPS) were $0.85, down 7% sequentially from $0.91 and down 10% from $0.95 year-earlier. Non-GAAP net income was $788.9 million, up 3% sequentially $767.3 million, and down 1% from $795.2 million year-earlier.

Profits did not keep pace with revenue growth because of costs from the Pharmasset acquisition from earlier in the year and a significant increase in R&D expense. Gilead is currently rolling out its newest HIV drugs like Stribild, which is helping revenue, but the R&D is not so much for HIV. The new R&D research is focused on hepatitis and oncology.

Why the emphasis on hep c? While Gilead Sciences has branched out into treatments for cardiovascular diseases, its primary expertise in in anti-viral drugs, particularly for HIV infections. Because of the effectiveness of its single-tablet, multi-drug combinations, Gilead dominates that market. Gilead also markets Viread for Hepatitis B. The past generation of Hepatitis C therapies have limited effectiveness, have a number of side effects, and cannot be administered orally.

Before the Pharmasset acquisition Gilead had four hepatitis drugs in phase II trials, and three in phase I, and said they would likely be made into a successful combination therapy. Pharmasset added Phase III candidate PSI-7977 (now Sofosbuvir), Phase II candidate Mericitabine, and Phase II candidate PSI-938, all for hep C. Pharmasset also brought candidates for HIV and hepatitis B treatment.

The latest set of results is for Sofosbuvir. The Phase 3 POSITRON study showed a response rate of 78% for hepatitis C (HCV) genotypes 2 and 3 when Sofosbuvir was combined with Ribavirin. It is notable that this is an all-oral regimen which does not include the using old standard, interferon. In tracking HCV note that a drug combination that works well with a particular genotype may not work with others. After 12 weeks of therapy and then an addition twelve weeks to see if the virus returned, HCV was not detected in 78% of patients. For those who are keeping track, Sofosbuvir used to be GS-7977.

Better still were the results from Sofosbuvir combined with GS-5885 and Ribavirin for genotype 1 HCV patients. Following 12 weeks of therapy and then 4 weeks without therapy, the response rate was 100%. Used with just ribavirin, Sofosbuvir had mixed results ranging from 84% for genotype 1 patients with no prior treatment down to only 10% response for genotype 1 patients who had not responded to prior treatments. For genotype 2 and 3 mixes, the range of responses was 60% to 68%.

Note that 100% cure rate is not necessary for FDA approval. As long as a combination can be found that does well with previously-untreated patients or that helps patients who were not helped by current therapies that include interferon, with about a 40% cure rate, the drugs could fulfill an unmet medical need.

At the same time it is a race, since other companies are also trying to break into the all-oral hepatitis market. It is a huge market. An estimated 150 million people world-wide have chronic hepatitis C, with the U.S. figure likely somewhere between 3 and 6 million (many people have undiagnosed HCV). For a less positive spin on the overall competition in hepatitis, I try Lessons from the Liver Meeting at Seeking Alpha.

Using the standard trailing 12-month ratio, Gilead's current P/E is 23.3. That is up quite a bit from earlier in the year. Conservative investors may want to wait until Gilead has actual FDA approval for a hepatitis C before extrapolating their chickens. As usual, the problem is by that time the stock may be priced even higher.

I don't think the current market has even priced in the true future value of Gilead's current drugs, much less the potential of a Sofosbuvir cocktail. In my particular case I feel comfortable with looking to the continued appreciation of my current holdings. I might still buy if the hep C data keeps getting better without a corresponding rise in the stock price. I have portfolio rules that restrict any stock to a maximum percentage of the entire portfolio, and could be forced to sell some if the stock rises too rapidly in price, though that seems unlikely at present.

Even with a great growth potential Gilead has, there are the usual risks from competition, macroeconomics, failure to receive FDA approval, etc.

Keep Diversified!

Disclaimer: I am a long-term investor in Gilead Sciences. I will not trade in the stock for a week from today.