Mike & Mark: Time to Get Long Gilead (GILD)?

by Mike Khouw January 5, 2017 11:52 am • Trade Ideas

After a 1.5-Year Selloff, It’s time to Get Long Gilead Sciences, Inc. (GILD)

Gilead Sciences, Inc. (GILD) is a research-based biopharmaceutical company. Through research and development they discover, develop, and commercialize innovative medicines designed to treat or cure diseases that currently have no or effective treatments.

The company has 11 different medications for the treat infectious diseases like HIV and they have additional drugs in the pipeline as well. GILD has 5 medications for the treatment of liver diseases, and 1 for the treatment of blood cancer. Furthermore the company has 3 pharmaceutical compounds for the treatment of cardiovascular disease like hypertension (high blood pressure) and angina. Finally, GILD sells an inhalable antibiotic for the treatment of cystic fibrosis. Many of these drugs are the foundation of specialized treatments and are very expensive. Gilead Sciences also sells more “mass market” pharmaceuticals like the popular anti-viral drug Tamiflu, and anti-fungal drugs as well…

Like many big companies, GILD has a deep pipeline of potential new treatments. The company’s Hepatitis drug “TAF” is under regulatory review in the E.U. The company has 10 other drugs in phase three trials and they have 14 in phase II trials. Theses drugs are designed to treat such ailments as HIV/AIDS and liver diseases, the hepatitis B virus and hepatitis C virus, inflammation, cancer, serious cardiovascular and respiratory conditions like Cystic Fibrosis, not to mention treatments for diabetic nephropathy and Ebola as well.

In the final analysis, GILD has been successful in developing treatments that improve public health. With their deep pipeline of treatments, we think the company is well position to continue for decades to come. GILD is a relatively young company. It was founded in 1987. In the last 4 quarters, the company generated over $31.6 billion in revenue and $15.1 billion in profits (or $10.79/share).

Technically, the company’s stock price began to fall about a year ago about the time when various contenders for the President of the United States talked about the possibility of price controls on high priced drugs. But the RSI indicated in the chart below shows that the stock had become overbought after an explosive rally and that a consolidation was over due. Investors were anticipating a drop in revenue on some of its drugs that were coming under competitive threat. “Harvoni”, GILD’s Hepatitis C drug for example, has seen its revenue fall by almost $1 billion since its sales peaked in H1-2015. The share price has been trading the better part of the last 6 months in the low to mid 70s. The MACD tells us the share price is marking time and we think there is little downside risk from here.

We like the valuation of this company. It trades at a PE of 7 based on both trailing and forward looking earnings. EV to EBITDA is just 5.4 and the firm generates an 85% return on invested capital. These multiples suggest this is a ridiculously cheap stock. The question is, “Why does the market put such a low valuation on a company with such great products and technology?” The short answer is, sales and earnings are no longer growing. Sales were down sequentially the last 4 quarters as were earnings.

We think the market has priced in a worst-case scenario and any surprises from here on are more likely to be positive than negative. GILD is and will remain a very profitable company. Every company suffers some ups and downs. In the pharmaceutical industry, companies are constantly dealing with pricing pressure on older products as they roll out new one. We think the market is giving investors a buying opportunity.

If you agree with this thesis, investors might consider taking a long position in this stock if it fits into their portfolio and longer-term strategy. Since the stock is in a basing pattern, the share price could simply trade sideways for a time before they move higher. If you believe that this is a more likely scenario, you might consider an alternative. That alternative strategy is to buy the stock outright and sell a call against it for additional income. With the share price trading at $76.60, the market prices a buy-write using the June 82.50 strike call at $73.55 per share equivalent.

The cash cost of this trade structure is $7355 per 100 shares of stock and one short call. Selling the June Call should allow the investor to collect 2 dividend payments estimated to be $47 each in addition to the option premium. The breakeven level is $72.61 (including dividends), which about 5% lower that the current price. A random walk suggests there is a 55% chance this trade succeeds. Naturally, we think the odds are better than that, for all the reasons discussed above.


 Mike Khouw and Mark Guthner are co-authors of The Options Edge (available on Amazon).

Michael Khouw is a 20 year veteran of the financial services industry with broad experience as a strategist, analyst, portfolio manager and proprietary trader of equities, commodities and equity and index derivatives for both buy-side and sell-side firms. (follow on Twitter)

Mark W. Guthner is a veteran of the financial services industry. His skills and experience stretch across multiple disciplines including trading, portfolio and risk management, securities analysis and valuation, investment banking and financial technology as well. (follow on Twitter)