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Gilead Sciences: Despite Boost From COVID Treatment, Outlook Remains Neutral

Published 12/15/2021, 10:14 PM
Updated 07/09/2023, 06:32 PM
  • Gilead Sciences has near-term upside potential due to the widespread use of Veklury (remdesivir) to treat hospitalized COVID-19 patients
  • The shares are cheap, but the 3-5 year outlook for growth is quite poor
  • The Wall Street consensus outlook is bullish
  • The market-implied outlook (calculated from options prices) is slightly bearish for 2022

Gilead Sciences (NASDAQ:GILD) reported strong Q3 results on Oct. 28, beating consensus expectations by more than 50% (Source: E-Trade). The revenues from Veklury (remdesivir), used to treat hospitalized COVID-19 patients, provided a major boost for Q3, with sales up 120% YoY and contributing more than 25% (see slide 7) of the company’s total revenue.

GILD has a YTD total return of 24.24%, almost identical to the total return of the S&P 500 over the same period. The shares are currently about 3.5% below the YTD high closing price of $73.03 on Aug. 17.

GILD 12-Month Price History

Source: Investing.com

GILD’s longer term performance has been disappointing, with the 3-year total return at less than half that of the Drug Manufacturer industry as a whole (as defined by Morningstar). The 5-year performance is even worse, with annualized total return of 2.55% for GILD vs. 11.56% for the industry. This lagging performance is a result of poor outcomes from a number of products in the development pipeline over this period.

GILD Trailing Total Returns Vs. The Drug Manufacturer Industry And The US Equity Market

Source: Morningstar

With a current dividend yield of 4.04% and 5-year dividend growth rate of 9.3% per year, GILD will be of interest to income-oriented investors. GILD initiated the dividend in 2015, so the company does not have a long track record from which to ascertain management’s commitment.

With a P/E of 12, the shares look inexpensive relative to current earnings. The P/E is this low because of concerns as to future earnings growth. The consensus 3-to-5 year expected EPS growth rate for GILD is essentially zero (-0.17% per year).

Analyzing a pharmaceutical company’s drug pipeline and making forecasts for earnings is a complex problem. Rather than attempting to perform a bottom-up analysis, I rely on two forms of consensus outlooks for GILD. The first is the well-known Wall Street analyst consensus rating and 12-month price target. The second is the market-implied outlook, which is a probabilistic price return outlook that represents the consensus view of buyers and sellers of options.

In brief, the price of an option on a stock reflects that market’s estimate of the probability that the price will rise (call option) or fall (put option) relative to a specific level (the option strike price). By analyzing the prices of call and put options at a range of strikes, all with the same expiration date, it is possible to calculate a probability distribution of price returns that reconciles all of the options prices.

I last analyzed GILD on Mar. 11, 2021, about 9 months ago. At that time, the Wall Street consensus outlook was bullish and the market-implied outlook was somewhat bearish. GILD’s low valuation was a plus, but the discrepancy between the analysts and the options market led me to a neutral rating overall. Since that post, GILD’s total return is 14.74%, as compared to 20.14% for the S&P 500.

I have calculated updated market-implied outlooks for GILD to the middle of 2022 and to the start of 2023. I am revisiting my rating on GILD on the basis of this outlook and the Wall Street consensus outlook for 2022.

Wall Street Analyst Consensus Outlook for GILD

E-Trade calculates the Wall Street consensus outlook by aggregating the views of 16 ranked analysts who have published ratings and price targets for GILD over the past 90 days. The consensus rating is bullish and the consensus 12-month price target is 9.92% above the current share price. Of the 16 analysts, 10 give GILD a buy rating and 6 assign a hold rating.

Back in March, the consensus 12-month price target calculated by E-Trade was $75, which was 17.7% above the share price at that time. The gains in GILD have reduced the expected upside for the next year. Put differently, the share price has risen faster than the consensus price target.

GILD Analyst Consensus Rating And 12-Month Price Target

Source: E-Trade

Investing.com’s version of the Wall Street consensus outlook is calculated from the views of 30 analysts. The consensus rating is bullish. There are more analysts who assign a neutral rating than a bullish rating, but only one analyst gives GILD a sell rating. The 12-month price target is 8.53% above the current price.

GILD Analyst Consensus Rating And 12-Month Price Target

Source: Investing.com

The Wall Street consensus outlook for GILD was bullish in March and continues to be bullish. The consensus 12-month price target is about 9.2% above the current share price (averaging the values from E-Trade and Investing.com). Combined with the 4.04% dividend, the expected 12-month return is 13.24%. This value is in the range of the 10- and 15-year annualized total returns, but is far above the 3-5 year returns.

Market-Implied Outlook for GILD

While the analysts assign a single target value for the price in 12 months, the options market assigns probabilities to the range of possible future prices. This probabilistic outlook reflects the market’s estimate of the uncertainties associated with GILD’s performance over the next year. I have calculated the market-implied outlook to the middle of 2022 by analyzing the prices of call and put options that expire on June 17, 2022. I have also calculated the market-implied outlook through 2022 by analyzing options that expire on Jan. 20, 2023.

The standard presentation of the market-implied outlook is in the form of a probability distribution of price return, with probability on the vertical axis and return on the horizontal.

GILD Market-Implied Price Return Probabilities From Now Until June 17, 2022

Source: Author’s calculations using options quotes from E-Trade

The market-implied outlook for GILD to the middle of 2022 is generally symmetric, with comparable probabilities of positive and negative returns of the same magnitude. The peak probabilities are slightly tilted to favor negative price returns. The maximum probability corresponds to a price return of -5.5% and the median price return is -2%. The annualized volatility calculated from this distribution is 28%, which is neither especially high or low for an individual stock.

To make it easier to directly compare the probabilities of positive and negative returns, I rotate the negative return side of the distribution about the vertical axis (see chart below).

GILD Market-Implied Price Return Probabilities From Now Until June 17, 2022

Source: Author’s calculations using options quotes from E-Trade. The negative return side of the distribution has been rotated about the vertical axis.

With this view, the elevated probabilities of negative returns vs. positive returns is more evident (the dashed red line is at or above the solid blue line across the entire chart).

Theory suggests that the market-implied outlook will tend to have a negative bias because investors, in aggregate, tend to be risk averse and thus willing to pay more than fair value for downside protection (put options). There is no robust way to estimate this bias, but a neutral outlook for a stock would be expected to show somewhat elevated probabilities of negative returns, as we see here. I interpret the market-implied outlook for GILD for the next 6 months as neutral with perhaps a slight bearish tilt.

The market-implied outlook for GILD through 2022, calculated using options that expire on Jan. 20, 2023, more obviously favors price declines. There is a better-defined peak in probability and this corresponds to a price return of -7.4% over the next 13.25 months. There is also a larger spread between the probabilities of negative returns and positive returns. This is a slightly bearish market-implied outlook for GILD through 2022. The expected annualized volatility calculated from this distribution is 27%.

GILD Market-Implied Price Return Probabilities From Now Until Jan. 20, 2023

Source: Author’s calculations using options quotes from E-Trade. The negative return side of the distribution has been rotated about the vertical axis.

The market-implied outlook for GILD is neutral to the middle of 2022, turning slightly bearish for the full year. The expected volatility for the 6- and 13-month outlooks is about 27%.

Summary

Gilead reported strong Q3 earnings, due in large part to sales of Veklury (remdesivir). If there are ongoing surges in COVID-19, this revenue boost is likely to persist.

To grow earnings in the longer term, the company needs to move new drugs through the development pipeline and get them to market. Given historical challenges, the outlook is mixed. The poor 3-5 year consensus outlook for GILD reflects a lack of confidence in the company’s ability to execute effectively.

The Wall Street consensus outlook remains bullish, with expected 12-month total return of 13%. As a rule of thumb for a buy rating, I want to see expected total return that is at least half the expected annualized volatility.

GILD is just below this threshold, using the market-implied outlook’s expected volatility. The market-implied outlook for GILD is neutral to the middle of 2022, but slightly bearish for the 13.25-month period to Jan. 20, 2022. With the bullish view from the analysts and the bearish view for 2022 from the market-implied outlook, I am maintaining my neutral rating on GILD.

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