Gilead Sciences Inc (GILD) Stock Purchase – Undervalued and Unloved

It seems strange that a company with $32 billion in revenues, $18 billion in profits, a cash hall of $21 billion on the balance sheet and free cash flow yield of 17% is currently hated by investors. But that is exactly the sentiment surrounding Gilead Sciences Inc, the mega biotechnology company hat discovers, develops and commercializes innovative medicines in areas of unmet medical need. Gilead has over the past year been out of favour with investors with its stock price crashing over 20%. It is now valued at a very lowly price earnings multiple of just under 7, has a dividend yield of 2.4% and has a dividend pay-out ratio of of only 16%. At these valuations, Gilead is definitely a risk worth taking.

Gilead has had an astonishing run over the past few years. it soared to prominence almost overnight with its 2011 purchase of Pharmasset, which netted blockbuster hepatitis C (HCV) drugs Sovaldi and Harvoni. To say it was simply an ordinary growth stock is an understatement. Since 2011, the biotech giants revenues have quadrupled and its market cap tripled. What led to this explosive performance is the fact that the company has the fastest growing drug in history. Since Sovaldi and Harvoni hit the market, the share price has rocketed from $25 to a peak of $120, an impressive 380% gain. Yet today, the share price languishes at $78 even though nothing fundamental has changed within the business.

Why Gileads share price has fallen

With any pharmaceutical company, the first thought would be that its blockbuster product is coming to the end of its patent protection period. But this is not the case with Gilead. It has patent protection well into the next decade. Yet still, sales of the top selling drugs, which count for 60% of Gileads sales, are declining already – much earlier than expected. This has spooked and scarred many investors and cause a lot of them to sell the company’s stock and bring it to trade right down at the lowly P/E multiple of just under 7. Maybe this rock bottom earning multiple is justified. For all I know, Gilead could be a value trap. But this is a risk I willing to take as i still fell Gilead is in good shape.

Firstly, let’s look at the HCV market which Gilead dominates. The company still has a commanding lead in this category. Its drugs outsold its two leading competitors by more than $3 billion in the second quarter. Even though the company has had to provide discounts in order to keep customers from picking other options, the HCV drugs provide a healthy cash flow for Gilead and will continue to do so in the future; albeit at a lower rate.

Gilead has also been active in the HIV drugs market. This has been a bright spot for the company with Genvoya and Descovy expected to combine for more than $5 billion in sales by 2019.

Outside of HCV and HIV, the company has still to prove what it can do. But Gilead has one other weapon in its arsenal, its huge cash position. With over $28 billion in the bank, the company can use this to make acquisitors, pay dividends, or use it to financially engineer eps figures by buying back stock and reducing the share count akin to what IBM has been doing. And the great news is, this cash position is growing by the day.

My Purchase of Gilead

I made my purchase last week and was able to buy 15 shares of Gilead for £60 a piece, or $78 in USD terms. To me, Gilead as these prices just screams buy. The pessimism against the company and its products by investors is so high right now that it has become a a proper value play.

Event though company does not have a history of consistent dividend increases over the years, as it has only just initiated its first dividend last year, I do believe that Gilead will become one of the great growth stocks in the years to come. The company currently makes a profit of $11.76 a share but only pays out a dividend of $1.88 meaning that the payout ratio is only 16%. This gives Gilead plenty of room to keep increasing its dividend payout in the years to come – even if profits stagnates or fall.

As I am a foreign investor, i.e. not a US based investor, I unfortunately will not get paid the full dividend the Gilead declares. This is due to withholding tax on US dividends. Usually, the withholding tax rates for US dividends is 30% but as I have completed the W-8BEN form, only a 15% withholding tax rate is deducted.

Taking all things into account and at current exchange rates, my 15 shares of Gilead will buy me £18 in dividends over the next year. And as I expect Gilead to be a solid divided growth stock going forward, I expect my dividend to increase by a double digit percentage the following year.

Whilst the yield of close to 2% right now does not sound like a lot, investing in companies that consistently increase their dividends can lead you to having a much higher yield on cost in the years to come. Suddenly a 2% yield on cost can turn into a 12% yield on cost. This is the power of dividend growth investing.

Buying American shares with the weak pound (£)

I do believe that the GBP (£) is really low right now due to all the uncertainty that has come about as a result of Brexit. I think that the GBP will appreciate from current levels of £1 : $1.3 to reach long term equilibrium of £1 : $1.4 – £1 : $1.5.

If GBP (£) does appreciate against the USD ($), it means that I will lose out as my purchase becomes more expensive. Just like foreign shares in your portfolio becoming worth more in GBP terms in the aftermath of Brexit due to the sharp plunge of the pound, the reverse is also true if GBP appreciates.

So say the rate moves to £1 : $1.45, it means that instead of my purchase price in USD terms being $78, it jumps to $87 (£60 * 1.45). So if the pound appreciates to £1 : $1.45 tomorrow, I would have an immediate loss of 11%.

But I am not at all worried about that. There are a couple of reasons for this:

  • Predicting rate movements is futile, even traders whose job it is to make these predictions get it wrong most of the time. It is better to buy into a good business whose value you know will appreciate over time instead of guessing how a certain rate will move. If you want to play the speculative currency game, join a platform like etoro.
  • Margin of safety. Even if the rate moves against me tomorrow thus making my initial purchase price to be $87 a share, I would not care. This is because I still feel that Gilead is undervalued even at $87 a share.
  • Gilead conducts business overseas (outside the US) and thus does generate revenue in foreign currency. So if the USD get weaker, it will be able to generate higher revenues and profits as it can now buy more dollars with its foreign earnings. Higher profits generally lead to increases in stock prices. Buying into an multinational business acts as a natural currency hedge for an investor.

So you see, it is pointless to think about currencies when making an investment decisions. It is far better to use your time to identify and understand wonderful business that generate revenue regardless of the macroeconomic climate.

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