(Published Feb. 15 by Bob Ciura)
Biotech giant Gilead Sciences Inc. (GILD, Financial) has only paid a dividend since June 2015, making it a relatively new dividend-payer.
Most biotech companies reinvest as much cash flow back into the business as possible to fund research and development of new drugs.
However, Gilead recently increased its dividend by 10%.
With only two dividend increases under its belt, Gilead has a long way to go to become a Dividend Achiever, a group of 272 stocks with 10-plus years of consecutive dividend increases.
You can see the full Dividend Achievers List here.
But Gilead is no ordinary biotech stock. It has a highly profitable business model and a war chest of cash on the balance sheet.
It has more than enough resources to invest sufficiently in R&D and reward shareholders at the same time.
We will discuss Gilead’s financial performance in the past year, its future growth outlook and the sustainability of its new dividend rate.
Business overview
Gilead has a focused product portfolio, emphasizing a few core treatment areas. These include HIV and AIDS, liver disease, oncology, cardiovascular and respiratory illnesses.
Source: Investor Fact Sheet, page 1
Gilead’s flagship products are its HCV and HIV franchises. These two segments represent the vast majority of the company’s annual sales:
- HCV (49% of sales)
- HIV (44% of sales)
- Other Products (7% of sales)
Gilead enjoyed explosive growth over the past several years due to Ă‚ its HCV portfolio, Ă‚ specifically its hepatitis C medications, Harvoni and Sovaldi.
Since then, Gilead has endured a prolonged slowdown. Sales of its HCV products declined 23% in 2016.
Source: 4Q Earnings Slides, page 10
Part of this is simply Gilead becoming a victim of its own success. 2014 and 2015 were landmark years for the company, in which sales soared 122% and 31% respectively.
As Gilead’s HCV drugs claimed market share and cured patients, a decline in revenue was inevitable due to falling new patient starts.
But there are also external forces holding the company back.
Specifically, Gilead and the rest of the biotech field endured a difficult 2016, characterized by increasingly harsh rhetoric during the presidential election campaign.
As a result, there is a heightened level of regulatory risk facing Gilead over drug prices. Since the market loathes uncertainty, investors have responded by selling the stock.
Gilead shares have lost one-quarter of their value over the past year.
The good news is, Gilead is not sitting idly by—it has invested heavily in R&D and has enough cash in the bank to make a major acquisition in 2017, if it decides to go the that route.
These efforts are likely to restore growth in 2018 and beyond.
Growth prospects
As a biotech company, Gilead’s most important growth catalyst lies in its drug pipeline.
Its growth slowdown is a significant concern. Importantly, Gilead has continued to accelerate its investment in new product development. R&D expenses increased 69% in 2016 to $5 billion.
Source: 4Q Earnings Slides, page 14
These efforts are bearing fruit: Gilead has a well-stocked HCV pipeline to help offset sales declines of Sovaldi and Harvoni. Gilead enters 2017 with several new liver disease therapies in Phase 2 or Phase 3 of development.
Source: Investor Relations
One particularly promising new HCV product is Epclusa, which was launched in 2016 in various locations. Epclusa achieved $1.6 billion of sales in 2016.
In addition, Gilead has two HIV and AIDS therapies in Phase 3 (Bictegravir/F/TAF and F/TAF), which helped HIV product sales increase 17% in 2016.
It also has a large number of new oncology drugs in late-stage development.
Source: Investor Relations
Lastly, Gilead’s massive inflammation and respiratory portfolio should begin to see meaningful results in 2017 and beyond.
Source: Investor Relations
Inflammation and respiratory products are likely to provide Gilead with a third major business line going forward, in addition to HCV and HIV/AIDS. Product sales outside these two segments rose 14% for the year.
Gilead’s strategy is to introduce enough new products to replace lost sales from drugs reaching maturity. This has helped in the sense that Gilead’s declines moderated as 2016 drew to a close.
For example, fourth-quarter sales and adjusted EPS (excluding share-based compensation and non-recurring expenses) declined 3% and 2% from the previous quarter.
Dividend analysis
After the 10% raise, Gilead’s forward annual dividend rate rises to $2.08 per share. Based on its current share price, the dividend yield is now 3.1%.
This might seem like a run-of-the-mill dividend payout, but for Gilead, it is an abnormally high yield. Consider that when Gilead declared its first quarterly dividend in 2015, the stock was yielding just 1.5%.
Gilead’s dividend yield has effectively doubled in the past 19 months.
One reason for this is Gilead’s two dividend increases—but the far bigger reason is its plunging share price.
When the company paid its first dividend, its stock price was climbing toward $120 per share. Now, the stock sits at $67 per share—down by nearly half in that time.
Normally, a soaring dividend yield is a sign of trouble. And Gilead faces its fair share of challenges. But even if EPS continue to decline in 2017, there seems to be no danger to the dividend.
After the dividend raise, Gilead’s payout ratio is still just 21% based on 2016 EPS.
Additionally, the company has a very strong balance sheet. At the end of the last quarter, Gilead held $32.4 billion of cash, cash equivalents and marketable securities.
As a result, investors can expect continued dividend increases in the 10% range each year moving forward.
With such a low payout ratio and high earnings power, Gilead generates more than enough cash flow to invest sufficiently in R&D and raise its dividend.
Also, there is still cash flow left over to pursue a significant acquisition or share repurchase program to restore earnings growth.
Final thoughts
Gilead had a tough year in 2016, and another tough year is likely in store. The company’s 2017 forecast calls for an 18% to 25% revenue decline due to continued erosion of the HCV portfolio.
Even with a relatively dour forecast however, the company remains highly profitable with an excellent balance sheet.
While health care stocks with the longest track records of dividend increases are usually diversified companies like Johnson & Johnson (JNJ, Financial), Gilead is an attractive stock for a solid 3% yield and high dividend growth.
Disclosure: I am not long any of the stocks mentioned in this article.
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