The Most Undervalued Stock In The Biotech Universe

StreetAuthority Network

If you've been paying attention to the biotech and pharmaceutical space over the past few months (like my colleague David Sterman surely has), you know that these stocks have been hammered amid a sector rotation into late-cycle stocks. 

Big, profitable companies like Amgen (Nasdaq: AMGN), Biogen Idec (Nasdaq: BIIB), and Celgene (Nasdaq: CELG) fell by as much as 25%. Opportunities for both traders and buy-and-hold investors abound, as the stocks re-establish price support.

Yet my favorite stock in this group is the one that has fallen the furthest. 

Gilead Sciences (GILD) is a tremendously undervalued aggressive-growth biopharmaceutical stock. (As you might have guessed, David Sterman is also a fan.) Gilead makes and markets treatments for immune deficiencies and a host of other ailments. The company operates in North America, Europe and Asia Pacific. 

Gilead is a leader in HIV and hepatitis C therapies. Its Sovaldi drug, which the FDA approved late last year, has proved effective in combination with other medicines in curing hepatitis C. Sovaldi is joined in Gilead's portfolio by Stribild, a top-selling one-a-day HIV treatment, and the company's newest HIV medicine, Tybost, which boosts the function of other HIV medicines, including Gilead's Truvada.

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Propelled by hepatitis C and HIV drug revenues, Gilead reported a blowout first quarter last month. Sovaldi sales soared to $2.3 billion, far surpassing the $1.4 billion analysts had expected. Revenue for the quarter was $5 billion, 29% higher than Wall Street's estimates. Earnings per share (EPS) for the quarter rose to $1.48, 208% higher than the same period last year.

Wall Street's full-year 2014 EPS estimate for Gilead was $4.09 a mere two weeks ago. Once first-quarter earnings were reported, it became clear that analysts were woefully lowballing Gilead's potential, and they immediately raised their earnings targets. The current full-year estimate is $6.21 a share, representing a year-over-year increase of 243%. 

Gilead posted record net income of $3.1 billion on revenue of $11.2 billion last year, and the company is on track for another year of record sales and net income. EPS is expected to grow 24% in 2015 and 15% in 2016. 

The 2014 price-to-earnings (P/E) ratio is 12.4, on the low end of GILD's historical range. The low P/E takes much of the risk out of investing in biotech stocks. Gilead's low 2013 long-term debt ratio of 21% reduces another common risk factor: the burden of debt service. Even better, Gilead is currently working its way through a $5 billion share repurchase authorization.

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Pfizer's (NYSE: PFE) recent plan to purchase AstraZeneca (NYSE: AZN) has put the mergers-and-acquisitions spotlight on companies which are successfully developing new drug therapies. Standard & Poor's expects "a favorable M&A climate, as large pharmaceutical firms move to offset lost revenues from expiring drug patents and large biotechs bolster their drug pipelines amid maturing products."

Any large pharmaceutical company looking for a takeover opportunity to enhance its drug portfolio should look no further than Gilead. For comparison, AstraZeneca's EPS are expected to decline for the next three years, yet the stock's trading at a 2014 P/E of 19 on the buyout offer. In comparison, Gilead has rapidly rising EPS and a low P/E.

If a buyout offer also elevated Gilead's PE to 19, that would give the stock a price of $118, an increase of 54% over the current share price. The case could be made that Gilead would demand an even higher buyout valuation because its earnings growth is much more attractive than AstraZeneca's.

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There are currently 23 "buy" recommendations on Wall Street for GILD and four "hold" recommendations. Institutions own 93% of the stock. Clearly, the Street expects Gilead's tremendous earnings growth to benefit its share price.

When GILD ran up to just shy of $85 in late January, I wrote, "I wouldn't personally chase the shares after the last week's run-up, but would rather watch the share price closely, and jump in on a pullback." The stock rose a few cents higher by late February, then fell 25% to a low of $63.50 when health care stocks overcorrected during the recent market pullback. 

Risks to Consider: Aggressive-growth stocks like GILD are typically more volatile than the broader market. Gilead has also been sued repeatedly by Idenix Pharmaceuticals (Nasdaq: IDIX), in part over ownership of the drug compound Sovaldi is based on.

Action to Take --> Look for Gilead to trade between $73 and $84 in the short term, restrained by weaker momentum among its pharmaceutical peer group. The stock is undervalued at any recent price, but I would especially accumulate shares under $78.50.

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