Gilead (GILD) – The War on Drugs

by riskreversal November 7, 2016 1:12 pm • Trade Ideas

Shares of Gilead (GILD) are down 40% from their all time highs made in July 2015. You know the reasons, increased scrutiny on drug pricing, moderating sales growth resulting from price declines for their blockbuster Hepatitis C drug and uncertainty regarding how they will deploy their cash for M&A.  The stock went from being a hero to a goat in two years.

GILD 5yr chart from Bloomberg
GILD 5yr chart from Bloomberg

EPS and sales are expected to decline 9%/8% respectively in 2016 and 5%/6% in 2017, now trading at 6.5x expected 2016 eps and 6.9x expected 2017 eps, a 10 year low:

From Bloomberg
From Bloomberg

The company has a massive cash pile, nearly $32 billion, or about 32% of their $99 billion market capitalization. Despite the stock’s decline over the last 18 months, the company’s finance peeps have been fast at work, raising $10 billion in debt in Sept 2015, and $5 billion in Sept 2016, bringing the total to nearly $28 billion. I think it is safe to assume their will be large m&a in GILD’s near future.

The stock is in an obvious free-fall as biotech investors fear a Clinton win, and Senators Sanders and Warren having greater influence in the new administration if the Dems were able to take back the Senate.

The next real support for GILD is down around $64, the April 2014 low, which is another 15% downside for those who think the stock continues to melt given what has been a somewhat partisan issue on drug pricing and the need for some sort of corporate action.

Options prices appear a tad elevated for a stock with this sort of balance sheet, after this sort of move lower (down 40% from its all time highs) that now trades less than 7x earnings. 30 day at the money implied volatility is down from 35% pre-earnings to about 25%.  That said the two year chart of short dated implied volatility shows a floor near 20%:

From Bloomberg
From Bloomberg

So What’s the Trade?

Short term fears of a Clinton Presidency’s effect on company’s like GILD may be pricing in the worst possible scenario already. The chances of increased regulation and scrutiny is a sure thing, but the Senate majority is very much up for grabs with most models showing it right around 50/50 for seats (50 seats in a Democratic majority because of the VP tie-breaker) and that means Republicans could easily retain control 51/49 depending on a few extremely tight races in PA, NH, NC, NV. Further gumming up the works is a House that is almost certain to stay Republican. Assuming a Hillary win, as she names people to cabinet posts into year end, and we get a better sense of Senate leadership roles, fears for the stocks may subside. But we want to take advantage of near term uncertainty to finance upside later on. We can do that with a call calendar:


GILD (74.15) Buy the Nov/Jan 77.5 call calendar for 1.40
  • Sell 1 Nov 77.5 call at .45
  • Buy 1 Jan 77.5 call for 1.85

Rationale – This sells 30 vol in Nov and buys 25 vol in January. The ideal situation is for the stock to rally into Nov expiration but stay below the 77.5 strike. If that happens we can then roll the expiring Nov short call out to December or January and ideally to a higher strike creating either a vertical calendar or a straight call spread for cheap. The most that can be lost on this trade is 1.40, even if the stock were to collapse so this works as a nice defined risk strategy for those looking to pick a bottom while only risking about 2% of the underlying.