Gilead (tkr: GILD) develops, acquires and manufactures drugs primarily used to treat human immunodeficiency virus (HIV) and hepatitis C. Hepatitis is a viral infection of the liver that affects millions of people worldwide. We first bought Gilead several years ago because of our conviction that its first-to-market oral drug for hepatitis C, Sovaldi, would drive significant company growth. Harvoni, Gilead’s second hepatitis C drug, followed closely on the heels of Sovaldi. Unlike previous medication regimens for hepatitis C, Gilead’s drugs actually cure the disease in over 95% of cases. This means that people who previously would have required treatment for many years just to keep the virus in check are now permanently disease-free with Gilead’s drugs.

The pricing for Gilead’s hepatitis C drugs has been in the news off and on since the release of Sovaldi. There has been much hullabaloo about the $85,000 list price for a course of treatment. What the newspapers usually fail to mention is that the estimated lifetime healthcare cost for a hepatitis C patient who is not treated is $100,000. 3.2 million people in the US are chronically infected with hepatitis C, and there are 17,000 new cases per year. 70% of those infected with hepatitis C develop chronic liver disease and 20% will develop cirrhosis, or severe scarring of the liver. Hepatitis C accounts for one third of all liver transplants, which increase the lifetime cost of treatment for an individual to $380,000. Gilead has negotiated lower prices with government payers and is now subject to competition from other drugs that have come to market.

After a very strong initial rise in the stock price following the market release of Sovaldi and Harvoni, the stock was down in 2016 despite continued strong growth in product sales and earnings. Why? In addition to the general biotechnology sector downdraft, there seems to be concern about the number of patients that still need and want treatment and the increase in competition. The numbers referenced above tell us that there are still many patients who will benefit from treatment. Since the release of Sovaldi, 400,000 patients have been treated in the US. Treatment in Europe just started in 2015 and has yet to begin in most other developed countries. Regarding the competition, it turns out that hepatitis C drugs are not just “commodities.” Clinically, Gilead has the best medication in terms of side-effect profile and ease of administration. Gilead is also anticipating the launch of its next hepatitis C drug later in 2016, which will cover all six genotypes (different strains) of the virus. After considering all of this information, we believe that Gilead is markedly undervalued.

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