Portfolio and Pipeline Set Gilead Apart

Gilead Sciences GILD generates stellar profit margins with its HIV and HCV portfolio, which requires only a small salesforce and inexpensive manufacturing. We think its portfolio and pipeline support a wide economic moat, but Gilead needs HCV market stabilization, strong continued innovation in HIV, solid pipeline data, and smart future acquisitions to return to growth.

Gilead’s tenofovir (TDF) molecule--in Viread, Truvada, and older single-tablet regimens--historically formed the heart of the company’s $17 billion HIV franchise. The newest combo pills--replacing TDF with TAF--reduce bone and kidney safety issues and are seeing rapid uptake. Gilead’s biggest competitive threat in HIV is Glaxo GSK, whose Triumeq saw rapid growth in 2015. Also, Glaxo has launched two-drug regimens based on its integrase inhibitor Tivicay (Juluca in 2017 and Dovato in 2019) that also bypass Gilead’s drugs. However, Gilead’s Genvoya (2015), Odefsey (2016), Descovy (2016), and Biktarvy (2018) launches push patent protection into the late 2020s and are boosting the company’s market share.

The $11 billion Pharmasset deal brought key HCV drug Sovaldi. Sovaldi and Harvoni (a combination of Sovaldi and ledipasvir) peaked at more than $19 billion in sales in 2015. However, demand has been shrinking as patients are cured, and competition from AbbVie ABBV and Merck MRK has led to several rounds of significant price discounting. We expect Gilead and AbbVie to share a $5 billion-plus market in the long term.

Gilead is building a pipeline outside of HIV and HCV but will need more acquisitions to see strong growth. The acquisition of Kite (CAR-T therapy Yescarta) has brought only slow sales growth, and although the acquisition of Forty-Seven and its CD47 antibody magrolimab adds to the oncology pipeline, we’re more optimistic about the company’s immunology portfolio, including JAK1-inhibitor filgotinib from the Galapagos collaboration. Lead NASH program selonsertib recently failed in a phase 3 trial, but Gilead is exploring combination therapy with other mechanisms in NASH. Gilead also has the leading potential treatment for SARS-CoV-2, the virus that causes COVID-19; it could launch this year and see more than $1 billion in annual sales for treatment and stockpiling.

We Assign a Wide Moat Rating We think patent protection on newer HIV regimens and Gilead's continued dominance in the hepatitis C market will be enough to ensure strong returns for the next couple of decades. Gilead's expertise in infectious diseases and single-pill formulations is a part of its research and development strategy, which we see as one of the strongest intangible assets supporting the company's wide moat.

Gilead’s moat was formed by its leadership position in the treatment of HIV, with patented products that form the backbone of today’s treatment regimens. Despite numerous competitors, the company has established leading market share and spectacular profitability with its convenient, effective, and safe treatments. Gilead serves 80% of treated HIV patients in the United States. Management has done an excellent job of maximizing sales of the TDF molecule, which is present in Viread, Truvada, Atripla, Complera, and Stribild. That said, key patents are beginning to expire in Europe, and next-generation products could struggle to provide sufficient differentiation for reimbursement in all key markets. This puts pressure on the HIV franchise beginning around 2021.

However, we think the company has shown that it can translate its extensive understanding of the drug discovery and development process in HIV into new therapeutic areas, allowing it to achieve wide-moat status. Despite initial criticism of the high price that Gilead paid for Pharmasset in early 2012, the $11 billion acquisition gave Gilead the most valuable hepatitis C drug in the industry and also demonstrated the company’s ability to recognize the potentially unique nature of Sovaldi’s safety and efficacy profile compared with other, toxic nucleotide analogs. We think the company’s experience with another nucleotide analog, tenofovir, a key ingredient in all of Gilead’s HIV combination regimens, probably contributed to its recognition of Sovaldi’s value at an early stage in its development.

The molecule in Sovaldi and Harvoni has redefined Gilead as a powerhouse in the broader infectious disease market. Gilead is leading the way for all-oral treatments in the hepatitis C market, and it has a multi-billion-dollar product. We think the low resistance potential and pan-genotypic efficacy of Gilead’s regimens will allow the company to retain close to 40% of the global HCV market in the long run, despite competition from AbbVie and Merck.

Increasing Competition and Pricing Pressures Are Risks Global pricing pressure and the consolidation of pharmacy benefit managers could reduce Gilead's ability to charge price premiums for new drugs or extend patent protection. If Gilead's newest HIV products aren't perceived as offering significantly improved safety or efficacy versus its older HIV products, a large portion of its sales foundation could be at risk. Key patents on Gilead's top marketed HIV products will expire by 2021, and the company will need to see significant switching to newer products like Biktarvy to counter the negative impact from generic competitors. We estimate that more than 60% of Gilead's U.S.-based HIV sales volume represents government purchases, and higher rebates on some of these sales were implemented in 2010. Escalating overall healthcare costs and tight budgets could lead to continued, elevated pricing pressure in both the U.S. and Europe.

Gilead also paid a significant premium to acquire Myogen, and the failure of darusentan put pressure on Letairis to make the deal accretive. The $11 billion Pharmasset acquisition, the foundation for Gilead’s HCV franchise, allowed Gilead to generate more than $19 billion in HCV revenue in 2015 alone, but Gilead’s HCV business has declined steeply since 2016, as competition allowed pharmacy benefit managers like Express Scripts to aggressively negotiate pricing. Gilead and AbbVie continue to compete on price. In HIV, Express Scripts could exclude newer HIV products from its formularies once safe and effective competition--like Gilead’s own Atripla and Complera--lose patent protection. Glaxo’s two-drug regimen could also put pressure on pricing, and payers could get more creative, offering financial incentives for patients to take new combinations as patents expire.

Gilead held $25.8 billion in cash and marketable securities and $24.5 billion in debt at the end of 2019. It has continued to raise debt at relatively low rates (we assume a blended interest rate of just over 3%), including the $9 billion in debt and term loans to support the October 2017 acquisition of Kite Pharma. Gilead has used cash to fund aggressive share repurchases ($11 billion in 2016) and a relatively new dividend. The company’s HIV and HCV businesses also generate stellar cash flows, and despite declining HCV sales, Gilead will generate around $9 billion in free cash flow annually through 2024. We expect Gilead to use some of its cash for future acquisitions, particularly as tax reform allowed repatriation of overseas cash. Share repurchases have been dialed back significantly to fund dividend growth and acquisitions.

4-Star Stock We recently raised our fair value estimate slightly after factoring in the pending acquisition of Forty-Seven and oncology drug magrolimab (a slightly negative effect) and adding remdesivir for SARS-CoV-2 to our model. Overall, we think magrolimab could see probability-weighted sales approaching $1 billion, with initial sales starting in early 2023. We assign remdesivir a 70% probability of approval in 2020 as a treatment for COVID-19, but we assume a 40% probability of bigger sales in 2021-23 as governments stockpile the treatment, if the disease looks like it might become seasonal. We assume peak sales of $1.4 billion in 2021, as we expect progress with a vaccine could limit long-term sales potential.

We assume Gilead’s HCV business will fall near $2 billion in 2020, with annual declines remaining in the double digits for the next few years. We think that Gilead’s HIV/HBV franchise will level off around $18.5 billion in 2020, with TAF-based combination regimens (Biktarvy, Genvoya, Descovy, and Odefsey) offsetting declines from older drugs, but that the company could see mid-single-digit patient losses in the U.S. annually beginning in 2021. We still view Stribild and Complera generics as strong long-term competition for TAF-based regimens, particularly outside the U.S.

Overall, we forecast 2% sales growth and 3% non-GAAP earnings growth through 2023. Sovaldi’s and Harvoni’s high gross margins, strong operating leverage, and lower tax rate led to a 68% operating margin in 2015, and with shrinking revenue, we think these margins will stay in the 40s. We assume that cost-cutting will help offset margin pressure.

We include $1.2 billion in sales from Yescarta by 2023, with annual sales stabilizing around this level as usage expands to second-line diffuse large B-cell lymphoma therapy and other forms of blood cancer, but the competitive landscape gets tougher. We also assume an 80% probability of approval for filgotinib in rheumatoid arthritis.

We assume a 6.8% cost of capital for Gilead. We rate the systematic risk surrounding Gilead shares as below average and assume a cost of equity of 7.5% to align our capital cost assumptions with the returns equity investors are likely to demand over the long run. We assume a 5.5% pretax cost of debt to reflect a more normalized long-term rate environment.