Teva Pharmaceutical Industries – Buy Now?

TEVA is down from a high of $68, but that is never reason enough in itself. Let’s examine why it is down.

First, it acquired Actavis Generics for $33.43 billion and 100 million shares of Teva … total price about $40 billion. Teva funded the transaction mostly with debt, and it did so at precisely the wrong time. Although the acquisition was poorly timed, it did make Teva the largest producer of generic drugs in the world by far. But, another problem added to the poor timing. Generic prices in the US began to come under pressure at about the same time.

Then there is the absence of a CEO, which was the result of their CEO resigning in February of 2017 amidst an investigation for bribery in countries like Russia, Mexico and Ukraine. Teva had already paid $519 million to settle similar claims in the US in 2016.

The shares which were already down $30 from the high 60’s fell another 6%. Unfortunately, Teva had a hard time hiring a new credible CEO and though the stock did not falter further until August, the lack of a strong CEO weighed on prospects … and corporate operations and initiatives, no doubt, suffered.

Still, in the second quarter of 2017, Teva recorded $5.69 billion in revenue, about 10% higher than the same quarter in 2016, but earnings fell to $1.02 from $1.25 per share for the quarter. The revenues were above expectations, but the earnings were slightly below. It was in the same announcement that “headless” Teva reduced its earnings projection for 2017 from a midpoint of $5.10 to $4.40 and cut their dividend by 75%. The stock crashed, hitting a low of $15.22 on fears that Teva would struggle to pay its debt.

Another big issue is that Teva’s blockbuster drug Copaxone is due to face generic competition very soon. And Wall Street analysts have all gone negative on the stock (at the bottom?). So, no doubt, it will be a long slog for Teva … maybe. Stock prices often tend to move long before the reason for such movement actually happens. Every year, the demographics of aging move more in Teva’s favor, a fact which is now being ignored. Over the entire Western World, populations are aging and older people use far more pharmaceuticals than youth.

Further, Teva announced a new CEO recently, a very attractive and capable candidate. Kare Scholtz was appointed CEO this month. Teva’s stock flew 19% … too much too fast, but the stock has settled around $17. Schultz, a 30-year veteran of the pharms business, was the COO of highly successful Norwegian drug maker Novo Nordisk before taking over as CEO of Danish pharmaceutical producer Lundbeck, which Schultz successfully turned around in just two years. Lundbeck stock is up 250% since Schultz arrived.

Just last week, Teva announced the second part of a two-part sale of its non-core women’s health business for $1.4 billion adding to the $1.1 billion it received for the first part. This will be applied toward the $5 billion in promised reduction in debt for 2017. Debt by year end should be reduced to under $30 billion. Let’s not ignore the fact that Teva should have at least $4 billion in free cash flow, which can be applied to debt reduction. This would more than amortize all the debt far before it is due to mature.

And then there is the drug pipeline. Trying to predict just what comes through the pipeline of new pharmaceuticals is very speculative, but Teva has a much better track record on delivering new drugs than most and their new drug pipeline has never been as robust as it is now. So, there is potential for positive events in the next year.

At this point, Teva could be considered speculative, but the current valuation is a key mitigating factor. Teva is trading at less than four times earnings (P/E<4) and a price to cash flow ratio of 4.35. When we compare these numbers with the S&P 500 averages of P/E 24.25 and P/CF of 14.05 it is obvious there is a lot of bad news already discounted into the price … so Teva’s valuation provides a margin of safety. To the extent that the bad news does not happen and there are a few positive surprises, Teva has significant upside. In our view, sophisticated investors might want to own this stock for the long run … just a return to a P/E of 10 is not out of the question, and could double the stock.

Disclosure: This is not a recommendation to buy the stock, just to point out that there may be a good opportunity for suitable investors. And, certainly one could lose money should they invest. There are no guarantees. Also, we need to disclose that many of our clients own the stock as does my family.

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