Price fixing allegations in the generic drug industry. A backlash against drug price increases. Costly past acquisitions that piled on debt. Management turnover and fines for bribing officials for business. If Teva Pharmaceutical Industries Ltd (ADR)’s (NASDAQ:TEVA) stock wasn’t so darn low, I’d recommend investors run for the hills. The company is dealing with a number of self-inflicted wounds that are already healing.
Industry woes and competition in the cut-throat generic space will take longer to settle down, but the low earnings and cash flow valuation make the risk/reward tradeoff very appealing for Teva stock.
What Is Copaxone?
Copaxone is Teva Pharmaceuticals’ top selling drug. It is the leading treatment for multiple sclerosis in the world. Last year (2016), Copaxone brought in $4.2 billion in sales, or 19% of total company sales of $21.9 billion. Back in late January, a judge rejected four of five patent infringement suits that TEVA had made to fight off the advances of archrival Mylan N.V. (NYSE:MYL), which plans to introduce a generic version of Copaxone.
The suit surrounds a 40-mg version of Copaxone. Already, the 20-mg version is subject to generic competition from the likes of Momenta Pharmaceuticals, Inc. (NASDAQ:MNTA) and Novartis AG (ADR) (NYSE:NVS). If the 40-mg competition starts, Teva management estimates it will take $1 billion to $1.3 billion off current estimates. It could also shave between $0.75 and $0.95 off current earnings projections.
Teva Pharmaceuticals: Financials
For 2017, TEVA projects sales will grow 11% to a range of $23.8 billion and $24.5 billion and earnings will come in between $4.90 and $5.30 per share. Analysts seem a bit more skeptical and project profits closer to $4.80 per share.
Earnings could be reduced by the 40-mg Copaxone generic introductions, if they happen this year. Free cash flow generation should increase to between $6.3 billion and $6.7 billion. Based off the current shares outstanding, that works out to free cash flow of nearly $7 per share. That puts the free cash flow multiple (stock price divided by free cash flow) below 5 — a seemingly ridiculously low level.
Beyond Copaxone Looks Promising
Even if Copaxone competition comes to full fruition, TEVA stock still has a rather large portfolio of drugs and generic drug manufacturing prowess to keep itself up. In the central nervous system realm, Azilect reported sales of $410 million last year. In the respiratory space, ProAir and Qvar generate growing sales around $500 million each. Even without Copaxone, the branded specialty medicine space generated $4.5 billion in sales last year.
Generics brought in $12 billion in sales last year and will be further bolstered by the purchase of Allergan plc Ordinary Shares’ (NYSE:AGN) generic drug business. Within a few years, generic sales could reach above $14 billion. Profits amounted to $3.3 billion for a very healthy segment profit of nearly 28%. The branded medicine group generated an even stronger profit margin of 54%, or $4.7 billion total.
Bottom Line on TEVA Stock
The bottom line for Teva Pharmaceuticals is that, even with a worse-case scenario for Copaxone, the stock is a reasonably good value. TEVA stock trades at a single-digit price-to-earnings ratio, even if the 40-mg version of Copaxone is opened to competition this year. Free cash flow generation should easily stay above $5 per share, versus a stock price of only $32 per share.
Teva Pharmaceuticals’ dividend yield of 4.23% is also nearly double the market average and looks safe given the projected free cash flow generation. Debt is high, but again, the cash flow generation makes it look quite manageable.
Warren Buffett might describe the downside protection as a margin of safety. Even if Copaxone sales fall off the face of the earth, the other businesses look fully capable of generating profits and cash flow. Teva Pharmaceuticals is also appealing the earlier court decision on Copaxone 40-mg. The outcome is expected later this year, or early next. Finally, Copaxone is said to be difficult to manufacture, meaning any competition could be slow to ramp production.
TEVA stock has grown and the company has acquired its way to become one of the largest generic drug firms in the world. Its emphasis on branded drugs speaks to the difficulties of competing in the generic space and it suggests a combination of both business models might be best.
Once the dust settles, it is conceivable to see Teva Pharmaceuticals bounce back above $40 per share, well on its way to $50, and even a double to $64 within a few years.
It could be worse. Valeant Pharmaceuticals Intl Inc (NYSE:VRX) also went on an acquisition binge that loaded on debt. Investors are currently worried it could go bankrupt and it currently pays no dividend, unlike TEVA stock.
As of this writing, Ryan Fuhrmann did not own any shares of any company mentioned in this article.
