Wednesday, April 5, 2017

Gilead at a 52 week low is an income investor's bargain



I am an income investor. I love dividend stocks.  I really love dividend stocks with dividend growth.   Finding a dividend stock on which you can sell covered calls helps to create even better cash flow for the income investor.  Dividend stocks have repeatedly delivered outstanding return over time.  It is rare to find a quality dividend stock at a 52 week low but Gilead Sciences, symbol GILD, provides one of those rare opportunities.

As a stock in the 52 week low universe GILD has the following characteristics:


  • Low Valuation
  • Dividend Yield above 10 Year U.S. Treasury Yiel
  • Dividend Growth
  • Laddered Call Option Opportunity


As an income investor, I use specific criteria to buy my dividend stocks. I employ my strategy with strict discipline and I have been handsomely rewarded.  As an income investor, I want both current cash flow from a dividend, I want dividend growth because I know my future expenses will double every 20 years, and I look for covered calls to add even more income. 


Gilead Valuation:


We income investors are not chartists.  Yet when I look for stocks that are a bargain, perhaps a stock at a 52 week low, a chart is helpful.  Look at this 3-year chart and you will see a bargain.  GILD hit a 52 week low of $65.38 on February 10, 2017.  As of this writing GILD is trading at $66.95 a mere 2.4 % above the low.


 Source Schwab.com

Valuation is measured in many ways.  I write for the ordinary investor and like to use easy to find data.  P/E ratio (price divided by earnings) is easy to find.  The P/E ratio of the S&P 500 is about 26 (source mutpl.com.)  Gilead’s P/E ratio is 6.75.  Schwab predicts their forward P/E ratio to be 8.14.  By this measure, GILD is a bargain. 

Another valuation measure is Return on Assets or ROA.  When compared with the industry, GILD’s ROA of 24.81 is much better than the industry average of 13.80.


Gilead as an Income stock:

This is a 3-part explanation.  One measure is the current dividend.  Another is the dividend growth and the third is covered call option opportunities.

Current Dividend:

Gilead’s most recently declared dividend of $.52 was paid on 3/30/2017.  Annually that translates to $2.08 for a yield of 3.1%.  This yield beats the S&P 500 and it beats the 10 year US Treasury. 


GILD started paying dividends in 2015 at $.43 a quarter.  Free cash flow was 19,582 (m) in 2015.  Basic earnings per share for 2015 were $12.37 and diluted earnings per share were $11.91 with dividends of $1.29 paid out that year.  Cleary GILD had enough cash to service the dividends.

During their most recent quarter, revenues declined.  This is the result of competition for one of their drugs to treat Hepatitis C.   This competition has pressured the stock price leading to the low valuation.  Yet on a fundamental basis, Gilead still has annualized earnings of $9.40 per share.  With an annualized dividend of $2.08 that is a payout ratio of only 22%.   The cushion is formidable despite the competition. 

I am encouraged by the news that their Canadian operations announced some good news on EPCLUSA another of Gilead’s’ Hepatitis C treatments.   See this link


This article notes that 44% of patients have not yet been diagnosed which makes me think Gilead can maintain the cash flow needed to service their dividend.

Dividend Growth

If pressure on revenues continues, the stock price will be stuck in the mud but notice that the company has increased the dividend by 20.93% since inception.   As an income investor, I like that kind of growth.  I can live with a stock whose price is "stuck in the mud" when they grow their dividend.

Cash on the balance sheet during 2016 has gone up and down and ended at 11,895 (m) which is another cushion to comfort the income investor.  GILD should be able to continue to grow the dividend provided they can bring some more drugs to market or can take advantage of deals like EPCLUSA in Canada.

Covered Calls

Finally, income investors look for covered call option opportunities.  I like to ladder my calls.  I don’t want to lose GILD to the call buyer.  If one of the catalysts discussed below positively affects GILD’s fundamentals and the stock price soars, I want to benefit with no less than an 8% capital gain.  I also expect at least 1% yield on my basis for the call premium.  I often will sell calls on only part of my position because if I am right about the company’s potential and it does soar, I don’t lose it all on an assigned covered call.

 Let’s look at an example of 300 shares of GILD during 2017.  Basis is $66.12 on 200 shares (bought 2/8/2017.)  The other 100 share basis is $71.25 bought on 1/19/2017.  

 

 



You can sell how I laddered the calls.  I took a strike price that made sense.  Covered Call options can really boost income from a dividend stock as you can see from the three tables above.  These were actual trades.  It is important to remember options are volatile.  I do not trade options.  I use them to boost my income.  Patience is important.  Look for option opportunities every day.  Spread out your options by both expiration and strike price.

The income investor who wants to juice their income using covered call options has to be vigilant.  As news and analyst ratings change, the effect on option premiums can be significant.  

The table below shows the best option I could find today (4/5/2017.)  It assumes you would buy the stock today and sell an option with a strike price far enough out to capture the next expected dividend.

Covered Call sold 4/5/17             
18-Aug-17
Basis 4/5/2017
$66.81
Strike Price
$75.00
Call Premium
$1.07
Premium Yld on basis
1.60%
Dividend Expected Ex div 6/20/17
$0.52
Total Return if call exercised @ strike price
14.64%

When you look for calls, volume of calls traded is important.  The higher the volume the better the chance you will get your price.  In the case of the call noted in the above table, volume traded (on Schwab.com) is meager; only 14 contracts.  On a day when there is positive news, you might see that volume go up by 100 contracts.  The high flying stocks can garner many thousands of contracts.

Gilead Dividend Machine fundamentals:

As an income investor, discipline is critical to success.  I use the following criteria to select a stock.  EPS (earnings per share) must exceed dividend paid out.  Dividend must beat the 10 years U.S. treasury; dividend growth and revenue growth are expected and a solid balance sheet as measure by D/E ratio is important.  Covered call available helps tip the scale for me. 

 

The table below shows how GILD performs on these metrics. 

 


Gilead deviates somewhat from this discipline because their dividend history is so short.  
Another metric that stands out is the D/E ratio (debt to equity ratio.)   At 1.39 GILD’s debt is higher than I like.  The industry average is .79.  Source: https://www.stock-analysis-on.net/NASDAQ/Company/Gilead-Sciences-Inc/Ratios/Long-term-Debt-and-Solvency

Gilead’s D/E ratio of 1.39 is not a deal breaker.  Look at Clorox with a D/E greater than 9 and some think it is a safe stock.  But a lower D/E would be better.  I looked further into their ability to service both their debt and their dividend.  GILD has an Interest coverage ratio of more than 15.  The higher the number the better.  In my opinion, GILD has enough cash flow even with the competition for their Hepatitis C drug to service both.

Gilead is not a Dividend Machine yet.  I think GILD is a bargain basement opportunity to get a source of income at a low cost.  

Potential

Who know how long it will be fore Gilead to reach its potential as both an income stock and a growth stock.  Three catalysts are possible.  Pipeline, M&A, and activist investor.  These are known unknowns of this kind of investing.


Pipeline is difficult to evaluate for the non-medical academic individual investor but we all know how expensive it is to bring on a new drug.  The FDA process is cumbersome.  GILD has 9 drugs in phase 3 research.  Phase 3 means the drugs are being tested on humans but have not yet been approved by the FDA.  Nine drugs, it seems to me, is a nice pipeline. See this link for more information on their pipeline.   http://www.gilead.com/research/pipeline


M&A

Keeping a lot of cash on hand means GILD might consider buying income and growth by acquiring another, smaller biotech company that has an exciting pipeline.  I cannot speculate on this potential.  However, having 11,895 (m) cash as of 12/31/2016 (source MSN) means if they find a deal out there they just might go for it.

Equally interesting is the potential for another company to buy Gilead.  Again, I cannot speculate on this but with 9 drugs in phase three clinical trials Gilead could be an interesting acquisition target.

Activist Investors have made an impact on some stocks.  Look at Darden (DRI) as an example.  This of course is not a very good comparison as Darden is a restaurant stock. 

Activist investors in biotech are not uncommon.  Look at DepoMed.  Whenever, a stock is trading at such a low valuation as Gilead, the management needs to find a way to grow revenues or risk the threat of an activist investor intervening and if successful liberating value for you and me.

I repeat that Gilead (GILD) is not a Dividend Machine, but it is an income stock available at a 52 week low.

M*MoneyMadam

Disclosure:  Long GILD with covered calls