Since Friday’s Brexit announcement, the markets have been volatile, and the downward part of volatile can be viewed as a buying opportunity for the longer-term value inclined investor. With most valuations at stretched levels after 8 years of ZIRP, a correction would be much welcomed.

So was this a correction?

Honestly, no – and it feels still like much better opportunities are to be had in the coming weeks.

Right now I’m sticking with my simple 3-part plan for FI in 10 years:

  1. Keep freelancing & earning money.
  2. Keep saving money.
  3. Wait for my watchlist to turn green, then buy

As part of my Brexit sale celebration, I purchased 25 shares of Gilead Sciences, Inc (GILD) on 6/28/16 for $80.05 per share, for a total purchase price of $2,001.25.

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About Gilead

Gilead Sciences, Inc. is a biopharmaceutical company with 8,000 employees across six continents. They are in the business of discovering, developing and commercializing medicines to treat the following conditions:

  • HIV/ AIDS
  • Hepatitis B & C
  • Cardiovascular, metabolic, and respiratory conditions

While they have growing lines in all these areas, Gilead is the undisputed leader of the fast-expanding hepatitis C treatment market. It’s primary revenue drivers are their drugs Sovaldi, and it’s successor Harvoni, a once-daily oral treatment for HCV infection. With today’s approval of Epculsa, the pan-genotype HCV drug of the biotech giant is expected to play a key role in buoying HCV sales of the company thus safeguarding the leading share it holds in Hepatitis C market.

In the US the price of Harvoni is the highest in the world. With an average cost of $1,125 per Harvoni pill, and $94,500 per treatment, it is one of the most expensive drugs on the market.

As such there has been quite a bit of backlash – rightly or wrongly – over perceived “price gouging” by the company. Their new Epclusa hepatitis C drug, just approved by the FDA today,  is priced lower than Sovaldi at $74,760 for a course of treatment.

Another advantage – Harvoni’s efficacy is astounding – it doesn’t just treat HCV – it cures it. It’s cure rates are in the range of 94-99%, and it will cure the condition in just 3 months with zero side effects.

As mentioned in my stock screener, I only am interested in stocks that I have an understanding of as well as a company I want to own. Gilead fits both of these measures. While not an expert by any means, I did have an opportunity to work on Gilead when I was working for a pharmaceutical advertising firm, on Letaris, a drug used to treat PAH (Pulmonary Arterial Hypertension).

Is the company generating value for shareholders?

Larry Ellison once said of Google, “Google’s a one trick pony. But boy, what a trick.”

The same holds true for the iPhone and Apple.

With Gilead it’s their HCV franchise.

I don’t think “one trick ponies” are necessarily bad. It’s through these “one trick ponies” that these brands become cash cows and generate value, and get additional options to expand into new opportunities.

Firms that generate free cash flow margins (free cash flow divided by total revenue) above 5% are generally considered cash cows.

Gilead Science’s free cash flow margin has averaged about 45.1% over the past 5 years.

Gilead’s 3-year historical return on invested capital (without goodwill) is 82.5%, which is above the estimate of its cost of capital of 10.7%.

These value trends also look positive, with the firms ROIC increasing to 128.4% from it’s trailing 3 year average of 82.5%.

Moreover, Gilead’s revenue expansion has been greater than the media of both its peer group and industry group over the past three years. However, the future trend here is negative, as by virtue of its’ HCV franchise curing HCV, it ultimately will end up reducing the population it can serve.  The firm’s pace of revenue growth should start to fall under the median of its’ peer group and industry in the next 5 years.

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Looking at debt, calculating total debt load divided by the trailing 3-year annual EBITDA, arrives at a measure of 1.5 which is a relatively low debt load.

Is the company selling at or below fair value?

Currently the entire company is worth a $109 billion market cap as valued by the market.  Future forecasts for key valuation drivers results in a future free cash flow stream. Over the next 5 years assuming enterprise free cash flow expands at about a -1% compound annual growth rate, during years 6-10 a 0.7% rate, and assuming beyond year 20 (in perpetuity) the free cash flow grows at inflation (3%), then Gilead has a firm total equity value of $197 billion.

Dividing total equity value by diluted shares outstanding yields a $130 per share fair value estimate, with a range of $98-$163 based on different future scenarios.

My purchase price of $80.05 is 47% lower of the calculated fair market value, which I believe offers a high margin of safety.

Is the forward dividend safe?

Gilead has returned 3/4 of its free cash flow since achieving record revenue in 2015, including the initiation of its’ first ever dividend. Moreover the company has more than ample cash flows forecasted in the future to meet its’ dividend payments. Some of the risks around the business could negatively impact the business. For now the dividend looks safe.

What are the risks?

A rational investor might ask, why the market has placed such a low valuation on GILD, and the answer I think lies in some of the headwinds and risks, as follows:

  • The pharma industry is capital intensive on the R&D side, and then once the drug finally comes to market they get pricing power which is great. The issue is that brand drugs lose market exclusivity, which lets makers of generics generate intense price competition. Their HIV franchise will see important patent expirations in 2018 and 2021.
  • Gilead used to have a monopoly, but competition in HCV from Jannsen’s Olyssio and Abbvie’s Viekira Pak are rivals that are less expensive and are eroding market share. Pricing pressure and reduced willingness to pay for convenience could weight on Gilead’s growth.
  • Ongoing litigation with competitors could shave off some Sovaldi profits.

Conclusion

This is definitely not a set it and forget it kind of dividend stock, but the compelling valuation and strong cash flow for me indicate that this is a nice entry point with a high margin of safety.

As it would happen, I made the purchase a few hours before the FDA approved it’s new Epclusa hepatitis C combination drug, a combination of the biopharmaceutical company’s Sovaldi with its new velpatasvir therapy, is the first drug that treats all six major strains of the disease, and the stock rose about 5% today. More importantly, this helps to secure Gilead’s HCV dominance.

This purchase adds $47 to my annual dividend income, based on a $1.88 per share dividend.

Morningstar rates GILD at 5 /5 stars, with a $124 per share fair value estimate.

Sabrient rates GILD a strong buy, despite it’s “weak momentum.”

Markit Research & The Street rate GILD as a buy.

Long GILD & GOOGL.

Thanks for stopping by.