Teva Pharmaceutical: A Company In Transition

Dec.31.12 | About: Teva Pharmaceutical (TEVA)

Shares of Teva Pharmaceutical Industries (NASDAQ:TEVA) are trading about 20% off their 52 week high and are off about 9% for the past year. The shares exchange hands for 43% below the company's all-time high in 2010.

The company has hit a wall and its strategy has faltered. Teva is the world's largest generic drug manufacturer and also manufactures branded drugs. The company's major challenge is to replace revenue from branded drugs set to lose patent protection over the next several years.

On November 30th, Teva released non-GAAP estimates for the fiscal year ending December 2012. They expect net revenues of $19.5 - $20.5 billion with approximately half of the revenue coming from sales in the U.S. In addition, about $10.3 - $10.7 billion will come from generics. The company estimates that $7.6 - $8.0 billion will come from branded drugs. Earnings are expected to be $4.85 - $5.15 per share.

Earlier this year, Jeremy Levin, a well-regarded industry veteran took over as CEO. He started his tenure by announcing his intention to review the company's operations. This month, Levin revealed his vision to reshape the company into "the most indispensable medicines company in the world."

Levin's plan is, simply put, to move the company away from overconfidence on any one drug as it is now with Copaxone. This drug accounts for 20% of revenue and the patent expires in 2015. The plan is to grow the generics business in new markets and to benefit from a joint venture with Proctor & Gamble (NYSE:PG) on over-the-counter products.

Teva has already taken several steps to implement this new strategy. It has dropped development of 12 pipeline programs that did not fit with this new strategy while it has 15 drugs in late-stage development and another 13 in mid-stage.

Another part of Levin's strategy is to forswear the big acquisition and focus on small and mid-sized deals. The company recently announced several deals including one with Handok Pharmaceuticals of Korea and Xenon Pharmaceuticals.

Another aspect of Levin's vision to turn Teva around is an aggressive cost-cutting program. Levin seems to think he can squeeze $1.5 - $2.0 billion in cost savings from the company.

The market was not overly impressed with these revelations and the share price remains in decline. Does Levin have the formula for reversing Teva's fortunes? Is this a buying opportunity for those who can wait 2-3 years?

The company has not provided guidance for FY2013 yet. However, analysts surveyed by Thomson Reuters provide FY2013 revenue estimates ranging from $19,603 million to $21,096 million. Their EPS estimates range from $4.95 - $5.25. My own EPS estimate is a more modest $4.20 - $4.46 per share.

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Over the last 5 years, the y-o-y growth in revenues has remained in double digits. The current growth rate exceeds the average of the last five years. EPS growth on a y-o-y basis has been unstable with peak rates of 263% in 2007 and 197% in 2009. Average growth rates over different time spans have also been erratic. Average book value per share growth is showing a decline with equity growing 2.5% y-o-y as compared to the five year growth rate of 14.8%. Return on equity has fluctuated each year and has ranged from a low of 4.0% in 2008 to a high of 18.8% in 2005. ROE has averaged 11.9% for the past 5 years. Net margin has averaged 15.2% for the past five fiscal years and has dipped to 10.4% for the TTM.

Teva is a moderately levered company with a Debt/Equity ratio of 55.3%. It has a LTD to Free Cash ratio of 381.14%, a level I consider higher than I would like to see. However, the company does have a healthy free cash flow. The company's liquidity position is not very strong with a current ratio consistently below 2.0 whereas the industry maintains a ratio above 2.0. The current ratio stands at 1.4 and the quick ratio at 0.9. Cash from operations are $4,423 million for the TTM ending 3Q12 while free cash flow surged by 25.6% compared to the five year average of 7.3%.

Teva is paying a dividend of $1.04 per share for a current yield of 2.8%. The company also has a share buyback program. Since the end of FY2011, the share count has been reduced from 896 million to 869 million. This is a reversal of Teva's prior practice of diluting shares aggressively.

Cash and short-term investments amounted to $1,432 million at 3Q12 and $1,096 million at the end of FY2011. The company reported for 3Q12 LYD of $12,688 million and at the end of FY2011, $10,236 million.

Over the long term, receivables turnover ratio has remained in the low single digits. The ratio has shown some change from 3.1 in FY2010 to 3.5 in the last twelve months. Inventory turnover has been fairly stable for the past several years fluctuating between 1.8 and 2.0.

At the current PE multiple of 15.2x, Teva is well below the industry average of 25x. This is in line with the overall downtrend over the last several years and well below Teva's five year average PE of 25.2x. The forward multiple of 6.9x puts this stock in a highly favorable position vis-à-vis its peers and I expect the trend to continue for the near and intermediate term.

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From a value investing perspective, the price to book ratio is low to moderate but well below the company's five year average of 2.12 and the industry average of 8.41. I prefer the EV/invested capital ratio over PBV. The industry median EV/IC is 1.31 and the average is 2.47. The EV/EBITA for Teva is low compared to other industry players.

Share price estimates for Teva range from $41 to $55. My own estimate of FV is at the high end, $53.46.

In answer to the questions raised above, Teva Pharmaceuticals represents a buying opportunity for those investors with a long-term horizon and confidence in Jeremy Levin's strategy to turn the company around. The company is in the beginning stages of a long and possibly painful transition. Levin faces many challenges as he re-positions Teva in new markets and disengages from others.

I plan to wait until I see improvement and better returns on my investment.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.