Health care is a long-term growth industry, both due to the aging population as well as innovation to treat an ever-expanding number of conditions. Many health care stocks pay dividends as well, meaning income investors should pay close attention to the sector. Not surprisingly, large-cap health care stocks are a favorite for retail investors as well as institutional investors.
RA Capital is a hedge fund that invests in multistage life science investments. It has assets under management nearing $5 billion and has produced strong returns over recent years. The largest company the firm owns – by a wide margin – is Gilead Sciences (GILD).
Gilead is an undervalued dividend stock with an attractive 4% yield, making the stock an attractive option for value and income investors.
Business Overview and Recent Earnings
Gilead is a biotechnology company that focuses on antiviral medications and treatments. Its primary sources of revenue today are treatments for Hepatitis B, Hepatitis C, HIV, and cancer. Gilead is a large-cap stock with an $85 billion market capitalization, producing about $24 billion in annual revenue.
Gilead’s second-quarter earnings showed a weakening of revenue, posting a decline of 10% year-over-year. The company’s legacy Hepatitis C franchise struggled as Gilead’s treatment regime is effective enough that it cures patients, virtually ensuring declining revenue over time. Gilead saw treatment starts decline for its other treatments as well as doctor visits declined sharply due to COVID-19 shutdowns.
Gilead has growth avenues, including Yescarta and Bictarvy, which posted 30% and 44% growth year-over-year, respectively. Gilead also owns remdesivir, which has been used as an emergency treatment for COVID-19. We expect Gilead to post earnings-per-share of $6.95 for this year despite the revenue weakness seen in the first half of the year as Gilead’s other franchises should rebound into the back half of 2020 and into 2021.
Why A Return To Growth Is Likely
We expect Gilead to produce 5% annual earnings-per-share growth over the next five years, driven by the company’s lucrative HIV business, as well as other drugs it has in the pipeline. For instance, the company owns distribution rights for Filgotinib, which treats a variety of ailments, including rheumatoid arthritis, Crohn’s disease, and ulcerative colitis, all of which are large and accessible markets. Should remdesivir prove to be a long-term treatment for COVID-19, that could bolster growth further.
These revenue gains should lead to meaningful operating leverage, as Gilead has shown in the past. Pharmaceutical companies tend to enjoy strong operating leverage as revenue grows, as operating costs are relatively fixed, meaning costs are spread over more revenue dollars, improving profitability.
A recent decline in Gilead’s share price has caused the valuation to move into the favor of buyers as well. Shares trade for just 9.8 times our 2020 earnings-per-share estimate today, which compares favorably to our estimate of fair value, which currently stands at 11 times earnings. We, therefore, believe Gilead is attractively priced today for long-term holders.
Finally, the stock sports a 4% dividend yield, which is double that of the broader market, and several times that of a 10-year treasury. And, with a payout ratio of about 40%, the dividend is safe and should continue to grow for years to come.
The Bottom Line
Putting all of this together, we have a company with a large, established portfolio of treatments for ailments with sizable, accessible markets, but with meaningful growth prospects. The firm’s Hepatitis C franchise will almost certainly decline over time, but the sub-10 price-to-earnings multiple and 4% dividend yield make the stock very attractive for both value and income investors alike.
Given all of this, we see Gilead producing ~11% total returns in the coming years thanks to its dividend, valuation, and growth prospects. Gilead, therefore, is rated a buy on the basis of valuation and dividend income.
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