This Drug Company Might Struggle Despite Its Best in Class Drugs
Traders often say that it’s possible for a good company to be a bad stock. What they mean is that the company might deliver good products but for some reason, the financials are not stellar, and the stock price suffers.
One example of the good company, bad stock conundrum is Gilead Sciences (Nasdaq: GILD). This is a great company that brought to market a drug that cures hepatitis C. Just a few years ago, this disease needed to be treated for life and complications could lead to liver transplants.
Now, patients take Gilead’s drugs for 8 to 12 weeks, or the drugs of a competitor now that alternative drugs are available, and they are cured. This is a good company, doing good for society but the results may not be good for investors.
The company reported that total sales and adjusted profit were below the expectations of Wall Street analysts. The company also told analysts to expect sales for the full year to be lower than they expect.
This continues a negative trend in revenue. The chart below shows the dramatic rise in sales as the new drugs were introduced and the subsequent decline in sales as patients were cured.
Source: Standard & Poor’s
Declines in sales were led by sales of hepatitis C drugs Harvoni, Sovaldi and Epclusa. The two drugs delivered total sales of $1.15 billion, a steep 59% decline from the same three months a year ago. That was the single biggest year over year decline in the eight quarters since Gilead started reporting sales of hepatitis C drugs separately from its other antiviral products.
Analysts had actually been expecting even poorer performance. A report from Mizuho analyst Salim Syed noted that the consensus model called for sales of $1.02 billion.
“Recall that during the fourth-quarter call, management commented that they anticipate patient market share and pricing to stabilize toward ‘mid-2018,’ with more predictable albeit declining patient starts,” he wrote.
During the quarter, sales of Harvoni and Sovaldi declined across all major markets as U.S. sales of Epclusa also fell, Gilead said in a news release. Gilead cited increasing competition for its challenge in hepatitis C drugs. Harvoni lagged sales views by $710 million.
Sales of HIV and hepatitis B drugs climbed 2% to $3.33 billion. But new HIV drug Biktarvy brought in just $45 million in U.S. sales. That missed the consensus for $47 million, according to Syed’s week-ago report.
RBC analyst Brian Abrahams says consensus numbers between $41 million and $51 million for Biktarvy were overly bullish. He also noted uptake of cancer treatment Yescarta — acquired with Kite Pharma last year — was strong at $40 million in sales vs. the consensus view for $17 million.
“Strong Yescarta can’t offset soft HIV/hepatitis C (drug sales),” he said. “But the rest of 2018 looks better.”
Total revenue of $5.09 billion declined nearly 22%. Sales missed the consensus of analysts polled by Zacks Investment Research for $5.42 billion. Adjusted profit of $1.48 per share lagged by 18 cents and fell nearly 34% year over year.
For the year, Gilead reiterated guidance for $20 billion to $21 billion in product sales. The consensus modeled adjusted profit of $6.43 a share on $21.22 billion in revenue.
With disappointing guidance, the stock price is likely to continue in its current down trend.
The chart shows a strong down trend in price. Momentum, shown as the stochastics indicator at the bottom of the chart is bearish.
It seems unlikely that GILD will make a strong recovery from the recent sell off.
A Trading Strategy While Awaiting Better News
To benefit from the expected weakness in the stock, an investor could buy put options. But, high prices on put options suggests an alternative trading strategy. The option premium is high because the expected volatility of the stock is high. Options that are based on selling an option can benefit from high volatility.
In this case, with a bearish outlook, a call option should be sold.
Selling options can involve a great deal of risk. A spread options strategy can be used to limit the potential risk of the trade.
One strategy that is important to consider is the bear call spread. This trade uses two calls with the same expiration date but different exercise prices. Traders buy one call and sell another call. The exercise price of the call you sell will be below the exercise price of the long call, so this strategy will always generate a credit when it is opened.
The risk profile of this trading strategy is summarized in the diagram below.
Source: The Options Industry Council
The trade has limited up side potential and limited risk. But, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade.
The maximum potential gain with this strategy is equal to the amount of premium received when the trade is opened. The maximum loss is equal to the difference between the exercise price of the options contracts less the premium received.
A Bear Call Spread in GILD
For GILD, we have a number of options available. Short term options allow us to trade frequently and potentially increase our account size quickly. Short term trades also reduce risk to some degree since there is less time for a news event to surprise traders.
In this case, we could sell a May 18 $71 call for about $0.45 and buy an May 18 $73.50 call for about $0.15. This trade generates a credit of $0.30, which is the difference in the amount of premium for the call that is sold and the call.
Since each contract covers 100 shares, opening this position results in immediate income of $30. The credit received when the trade is opened, $0.30 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $220. The risk is found by subtracting the difference in the strike prices ($250 or $2.50 times 100 since each contract covers 100 shares) and then subtracting the premium received ($30).
This trade offers a potential return of about 13.6% of the amount risked for a holding period that is about three weeks. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if GILD is below $71 when the options expire, a likely event given the stock’s trend.
Call spreads can be used to generate high returns on small amounts of capital several times a year, offering larger percentage gains for small investors willing to accept the risks of this strategy. Those risks, in dollar terms, are relatively small, about $220 for this trade in GILD.
These are the type of strategies that are explained and used in our TradingTips.com’s Options Insider service. To learn more about how options can be used to meet your income and wealth building goals, click here for details on Options Insider.