Streetwise: Discussing Teva Pharmaceutical Industries

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In the story of “The Ugly Duckling” by Hans Christian Andersen, a homely little bird matures into a graceful swan. The story comes to mind once again because of Teva Pharmaceutical Industries, an “ugly duckling” that just might mature into a beautiful swan in the ensuing year or two.

Teva’s shares recently hit a one-year high, rising 4.6 percent to $45.45 after the manufacturer of generic pharmaceuticals indicated it plans to return to the deal-making strategy that made it one of the most acquisitive drug companies of the past decade.

“We have to do the clever deals that Teva was so good at doing in the past,” Chief Financial Officer Eyal Desheh said. Mr. Desheh’s tone signaled a major shift in approach from Teva’s former CEO, Jeremy Levin.

Erez Vigodman is the new CEO and one of his key responsibilities will be to reduce costs by $2 billion to make up for this year’s patent expiration of Copaxone, the company’s top selling treatment for multiple sclerosis.

Although having Copaxone coming off patent protection is an issue, it is not a death blow. Teva has received positive comments from analysts who see ongoing potential and have raised their target price, while the Soros Fund increased its equity stake in the company.

So what do so many others fail to grasp?

For one, Teva is the world’s largest generic company with an established specialty portfolio of medications. Therefore, Teva is strategically positioned to benefit from the changing dynamics of the global healthcare industry as it shifts from patented to generic medications.

Generics accounted for 51 percent of Teva’s total annual revenue in 2012. In the United States, Teva accounts for about 16.2 percent of all generic prescriptions. And Teva’s specialty pipeline includes candidates that focus on central nervous system and respiratory drugs, along with a selective innovation of products in the areas of oncology, women’s health, and biologics.

Yes, there is a concern over the patent expiration of Copaxone in the coming months. Yet, ProAir and Qvar are expected to add significantly to revenues. Teva also plans to enhance its existing brands, while developing products for Asthma and COPD with differentiated inhalers.

Teva has a solid respiratory pipeline with the recent FDA filing for approval of DuoResp, while a number of products in Phase II and III testing are designed to treat asthma. Approximately 8 percent of the U.S. population suffers from asthma and the number is growing. Successful entry in this arena will significantly add to revenue and earnings growth.

Teva trades at a conservative 9.72 times 2014 earnings. Revenues for the first six months of the year came in at $9.82 billion; down 2.7 percent year-over-year. Earnings fell from $1.72 billion to $178 million on the back of $1.62 billion in settlement, impairment and restructuring charges. Teva’s guidance has 2014 revenues at around the $20 billion mark, while 2014 non-GAAP earnings are estimated at between $4.85 and $5.15 per share.

The patent expiration of Copaxone could put $4 billion of revenues at risk. Yet, the nearly $2 billion in planned cost savings and an increased generics pipeline have the potential to overcome that problem. Nonetheless, two issues merit consideration, the restructuring and legal expenses that are inherent in Teva’s focus on generics, and the level of debt.

The intrinsic value of the shares using a discounted earnings model with an earnings growth rate of 9.37 percent is $40 (not surprising given the earnings decline), while the more conservative free cash flow to the firm model yields an intrinsic value of $98.25. My earnings estimate for 2014 is $5, with a 12-month share price estimate of $50 for a 10 percent capital gain. There is also an annual dividend yield of 2.5 percent.

Lauren Rudd is a financial writer and columnist. You can write to him at LVERudd@aol.com.


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