Gilead's Dividend Expected to Remain Safe Following $21 Billion Acquisition of Immunomedics

On September 13, Gilead announced plans to acquire oncology company Immunomedics for $21 billion.

Once the deal closes, we estimate Gilead's leverage ratio will increase from about 0.4x to around 2.0x, marking its highest level in at least a decade.

In light of Gilead's higher financial leverage, we are downgrading the firm's Dividend Safety Score from Very Safe to Safe.

However, Gilead expects to retain an investment-grade credit rating following the transaction, and we believe the company's dividend remains secure.

Not only will Gilead continue to have a solid balance sheet with flexibility to make more acquisitions to support its drug portfolio, but the firm's dividend should remain well covered by cash flow as well.

Analysts expect Gilead's earnings to rise nearly 30% in the year ahead, driven by sales of its COVID-19 drug Remdesivir.

As a result, Gilead's payout ratio is projected to decline from 45% to 36%, a very reasonable level.

The Immunomedics transaction is not expected to be neutral or accretive to Gilead's adjusted earnings until 2023, so we do not expect the deal to materially affect the company's payout ratio for the foreseeable future. 

Given this backdrop, management expects Gilead to continue paying a safe and growing dividend:

That said, as demonstrated by its low P/E ratio near 8x, Gilead has yet to convince investors it can return to sustainable growth.

Gilead's revenue slid from $32.6 billion in 2015 to $22.4 billion in 2019. During this period, the firm's hepatitis C drug franchise shriveled from $19 billion in sales to $2.9 billion.

Unlike most diseases, which are chronic and thus require a patient to continually take medications (sometimes for life), hepatitis C is a "one and done" disease.

In other words, the near 100% cure rate from Gilead's drugs resulted in a declining patient pool in developed markets.

Coupled with rising competition and price pressure, this major revenue headwind was not offset by Gilead's new medications.

Hepatitis C drugs now represent close to 10% of Gilead's revenue versus nearly 60% in 2015, so the company faces a more manageable level of exposure going forward.

Outside of hepatitis C, HIV drugs remain key to Gilead's cash flow generation, generating about 75% of revenue in 2019.

Two of Gilead's HIV treatments – Truvada and Descovy – accounted for 20% of firm-wide sales in 2019 and face U.S. patent cliffs in 2021 and 2022, respectively.

However, Gilead's next-generation Biktarvy therapy (21% of 2019 sales), which gained regulatory approval in 2018 and is patent protected through 2033, is winning over new and existing HIV patients. This should help Gilead maintain its command of 75% of the HIV drug market.

With Gilead's hepatitis C and HIV franchises facing questionable long-term growth prospects and rising political pressure to reduce U.S. drug prices (75% of Gilead's sales are in America), management wants to diversify Gilead's revenue into areas with more potential.

The market for cancer drugs has become one of the more lucrative areas for pharma companies.

Not only have advances in cancer research created new opportunities for drugmakers to discover treatments for patients, but many therapies command high prices, according to the Wall Street Journal.

Buying Immunomedics accelerates Gilead's efforts to diversify into cancer drugs. Immunomedics' Trodelvy therapy was approved by regulators in April 2020 to treat adults with triple-negative breast cancer.

The drug generated around $20 million of sales in its first two months, but analysts believe Trodelvy has potential to eventually peak at around $4 billion per year in revenue (representing about 15% of Gilead's firm-wide sales) and address other solid tumor indications over time.

If realized, this growth should help offset any weakness in Gilead's hepatitis C and HIV businesses.

Overall, Gilead seems likely to remain a "show me" story with investors as it seeks to return to sustainable revenue growth and reduce its dependence on a small handful of HIV treatments.

Immunomedics will require a few years to become a meaningful contributor to Gilead's financial results, but management has had success with major acquisitions in the past.

We expect Gilead's dividend to remain safe after the transaction closes and believe the firm continues to have some acquisition capacity to further enhance its drug portfolio.

However, investors have to be comfortable with Gilead's concentration in HIV drugs and ability to ward off intensifying competition in its legacy markets as it wades deeper into cancer drugs.