Teva Pharmaceutical Industries Limited (TEVA) cut its 2013 EPS and revenue guidance, moving it 12% below consensus EPS estimates and 5% below consensus revenue estimates. The conference call and the press release indicate that the company is going through a strategic shift and believes that it is entering the maturity stage of its life cycle. With a successful product portfolio in both generic and branded products, I believe TEVA is turning into a cash cow. The company is pursuing its cost saving plan more aggressively as compared to its acquisition plan. The street is expecting growth of only 2.9% in EPS over the next five years. This is just more proof that TEVA's product portfolio is maturing and it is unable to drive more growth from R&D or acquisitions. The new buyback program is another indication that the company plans to return more wealth to shareholders
TEVA at this stage should be looking to become a pure dividend stock and it will have to double its dividend yield to meet industry average. With one of the lowest payout ratios amongst comparable companies, TEVA can easily improve its dividend yield. Therefore I believe investors should expect a dividend hike at the December 11th December investor meeting. The Dividend Growth Model shows that if the company increases its dividend as I expect, the stock will be valued at $49; a 22% upside. I believe this is an excellent opportunity to go long TEVA.
Outlook Revision
Teva Pharmaceuticals surprised investors on Friday by revising its outlook for 2013. The company stock depreciated 5% after the outlook revision. Before the conference call, the market was expecting 2013 revenues of $20.8 billion and EPS of $5.65. According to TEVA it expects revenues to be in the range of $19.5 to $20.5 billion and EPS in the range of $4.85 to $5.15. The new EPS target is approximately 12% below consensus estimates and revenues 5% below estimates. Sell Side has updated their perspective on TEVA. Barclays and Credit Suisse lowered their Target Price to $42 and $51 respectively; GS target price is unchanged at $45.
The company is expecting the following revenues geographically:
United States | $10.0 to $10.6B |
Europe | $5.5 to $6.1B |
Rest of World | $3.7 to $4.3B |
The guidance indicates a YoY decline in branded products of $300 million. There is a slight decline in products such as Copaxone but it's been offset by growth in Qvar, Women's health, Treanda etc. The decline in Copaxone is driven by expectation of increased competition by orals entering the market in 2013. A primary contributor to EPS reduction is the increase in Selling and Administrative expenses. There are multiple reasons for the increase including, expenses related to Copaxone commercialization, increase in royalty payments and expenses related to pre-launch activities of new ventures e.g. laquinimod, Spiromax etc.
Analysis of Key Takeaways
To derive a wholesome picture from this outlook revision, investors should also take into account factors which can prompt TEVA to lower expectations. I believe a big factor behind this conservative outlook is the maturing drug portfolio. For example the biggest contributor to revenues i.e. Copaxone (20% contribution to revenues) is now facing competition from Novartis AG's (NVS) Gilenya and Biogen Idec's (BIIB) BG-12. Thus the company is preparing investors before the December 11th meeting, for the maturing industry for TEVA's drugs. This has also triggered the cost saving plan TEVA revealed on Friday. The company plans to save around $1.5 to $2 billion in the next 3 years. The focus will be on improving efficiency of operations, marketing and R&D; which will ultimately result in higher margins. Going forward, TEVA plans to make its acquisition strategy more focused and targeted. The focus would be on projects which can make higher contribution to maximizing margins and creating shareholder value. The management also stated that the company will replace closed legacy projects with renewed focus on 'CNS' and 'respiratory'.
Dividends and Buybacks
The focus would be to 'reward' shareholders in the short run and later invest in projects which can create further shareholder value. The management has pledged that in 2013 approximately 10M-15M shares will be repurchased. The issue of dividends is the most critical to this new phase TEVA is entering. The recent changes, such as cost restructuring, reduced R&D, emphasis on efficiency, conservative forecasts, indicates that the company management foresees TEVA entering the maturity stage. I believe TEVA is becoming a 'Cash Cow' from a 'Star'. A peek into FCF and CFO over the last five year reiterates our thesis.
$ millions | 2010 | 2011 | 1H2012 |
CFO | 4136 | 4134 | 1947 |
Total Cash & Cash Equivalents | 9811 | 4146 | 2250 |
Cash Per Share | 11.30 | 4.78 | 2.59 |
The company is maintaining a large amount of cash on its balance sheet and showing healthy CFOs. The dividend payout ratio of TEVA is approximately 42% and the yield is 2.55%. If we compare this with other maturing Pharma stocks, TEVA falls way behind on both.
Company | Dividend Yield | Payout Ratio |
Pfizer (PFE) | 3.5% | 67% |
GlaxoSmithKline (GSK) | 5.4% | 78% |
Merck & Co. Inc. (MRK) | 3.9% | 77% |
Johnson & Johnson (JNJ) | 3.5% | 77% |
Bristol-Myers Squibb Company (BMY) | 4.2% | 120% |
Eli Lilly and Company (LLY) | 4% | 53% |
The average dividend yield of comparable pharmaceutical companies is 4% and payout ratio is approximately 80% (70% if you exclude BMY). I believe TEVA will announce a dividend hike at its December 11th meeting and the recent 5% decline will make it easy for TEVA to achieve industry average yield. I used the Dividend Discount Model to calculate a value for TEVA as follows:
Growth | 3.0% |
Risk Free Rate | 1.9% |
beta | 0.73 |
Market Risk Premium | 6.0% |
Div Yield Current | 2.6% |
D1current | $1.03 |
Div Yield Expected | 4.0% |
D1 expected | $1.6 |
Required Return | 6.3% |
Current Value | $31 |
Target Value | $49 |
TEVA has announced a strategic shift and I believe the company will announce a dividend hike in the near future probably during the investor meeting this month. The above calculations show that if the company increases its dividends to meet the industry average, the value of TEVA can be calculated at $49 i.e. 23% upside. The company announcement also pointed towards reconsideration of dividend and blamed increased dividend tax as the primary reason behind holding off from a hike.
Conclusion
The outlook revision shows that TEVA sees itself as a maturing company. The company has already announced share repurchase of 10-15 million shares. I also believe the company will increase its dividend yield, which is way below industry average. If the company meets industry averages, it can be valued at $49. The payout ratio is approximately half of industry average. The solid CFO and cash reserves points towards capability of supporting a significant dividend hike. Copaxone will continue to drive revenues for the time being, high courts of England and Wales have already given its patent validity until 2015. Therefore I recommend investors to go long TEVA and expect a 23% upside.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
