Seeking Alpha
Recommended for you:
Profile| Send Message|
( followers)  

Introduction

For those investors willing to take a position in TEVA, I believe significant rewards are virtually guaranteed. The risk/reward make sense. As discussed below, TEVA has some big positives on the horizon, and its new management team has pledged cost cutting, and other sweeping reforms which I expect will take the stock higher.

I also believe that all of the negatives have already been built in to the stock price. Frankly, I think it's gotten to the point of being ridiculous given its current PE of 6.64 and a 2.75% yield based upon its 1/29/2013 closing price of $37.35.

Overview

Teva Pharmaceutical Industries, LTD (NYSE:TEVA) is the world's largest generic drug manufacturer, and it's the world's 15th largest pharmaceutical company. Although its based in Israel, it has facilities in North and South America, Africa, Asia and Europe. TEVA expanded rapidly during the last 10 years through a combination of conservative management and smart acquisitions and achieved a 27% earnings growth rate, with return on invested capital of around 20%.

But, over the past several years, shares of TEVA have truly been brutalized. Here's a brief bullet point summary of what's been going on with the stock:

√ It's dropped from a 2010 high of around $65 per share to $36

√ As the global economy recovered, TEVA's stock didn't

√ In December, TEVA lowered its 2013 guidance

√ It hit a new 52 week low on December 28th , 2012 as the market skyrocketed

√ The main headwind for the stock: Expiration of Copaxone Patent.

The Uncertainty of TEVA's Copaxone Franchise

Uncertainty about TEVA's Copaxone franchise (patent expiration in 2015) has been generally referenced as the main reason for the stock's under performance. Copaxone is currently the top selling drug for the treatment of multiple sclerosis, and in 2012 generated $3.6 billion or 20% of TEVA's sales. Obviously, losing 20% of sales (or a portion thereof) could be devastating.

Now let's take a look at some of the positives:

The Copaxone Issue May Not Be "Catastropic"

Although TEVA's Copaxone patent will indeed expire in 2015, it's not yet clear whether this would immediately lead to a generic version. In TEVA's favor, it's been reported that, due to the very specific chemical properties of this molecule, regulators could require separate clinical trials for any generic version. Thus, the time-to-market and costs for competitors would be significantly increased. This theory has repeatedly been reiterated by TEVA's management, ant its position appears to have found some degree of confirmation by the FDA, according to some of their past statements.

Some additional and highly relevant points relating to the Copaxone issue were recently presented by Gabriel Grego in his November 7, 2012 Article "Why Teva Pharmaceutical Is An Attractive Buying Opportunity" and published by NASDAQ as part of its "Covestor" Program. It reads in part:

Copaxone is currently being approved for a higher dose that can be administered three times a week, rather than daily. Copaxone has a very long history of effectiveness and safety. Its competitors are new to market and only have clinical trials, which are not error-proof.

Copaxone is a so-called "first line drug". Its competitors, at least for the moment, are still "second line". That means that patients receive the drugs of the latter type if, and only if, they did not respond to any of the first line drugs. This has to do both with therapeutic history and costs for health insurance companies.

Most importantly, doctors are extremely reluctant to switch a stable patient to a new drug. This last point is paramount and has been hinted at, a few times by Teva's management. We have made our own inquiries with neurologists in several countries. It turns out that MS is not just a normal disease, but it is characterized by acute episodes that may strike at any time.

The patient typically recovers after each episode, but never to the original level of functioning. In other words, after each acute episode the patient slides one step further down the disability scale. It is therefore of paramount importance to keep patients from experiencing acute episodes. Copaxone reduces the number of acute episodes experienced by patients. Therefore, it would be a bad idea to switch a patient away from Copaxone into a new drug simply because the new drug is oral: if a previously-stable patient does not respond to the new drug, he might well experience a new acute episode and slide irreversibly into a lower level of functioning. Besides, the patient might have adverse reactions to the new drug. This line of reasoning has been strongly confirmed by each and every neurologist we have interviewed.

In light of the three arguments above, we believe that Copaxone is not likely to experience a sharp, sudden decline. It is instead expected to decline gracefully over the years. We expect the bulk of the decline to come from pricing pressures, rather than volume drop.

Accretion From Smart Acquisitions That Were Initially Hard to Digest

Under the leadership of its former CEO Shlomo Yanai and Chairman, Eli Hurwitz, who died in 2011, TEVA embarked upon an aggressive campaign of acquisitions, exchanging billions of dollars for future growth and greater market share. However, as is often the case, the merger related costs of these acquired entities were greater than expected, but that's history since these acquisitions are now becoming accretive. TEVA's most notable acquisitions were:

Target CompanyDateLocationCost
Barr PharmaceuticalsDecember, 2008USA$7.5 Billion
RatiopharmMarch, 2010Germany$5.0 Billion
CephalonMay, 2011USA$6.8 Billion
Taiyo PharmaJuly, 2011Japan$934 Million

New Leadership: Pledges of Cost Cutting & Sweeping Reforms

Following the resignation of CEO Shlomo Yanai, Jeremy Levin a former senior executive at Bristol-Meyers Squibb took over the reigns of the Company in late 2011.

On more than one occasion, Mr. Levin has proclaimed that he wants TEVA to be more responsive to shareholders."Teva will look like a very different company going forward," he told analysts on a conference call. Levin said TEVA is determined to be more transparent with Wall Street and says there are "different levers" the company can pull to return value to shareholders, including potentially increasing stock buybacks and allocating cash more efficiently.

As part of his reorganization of TEVA, Levin plans to cut $1.5 billion to $2 billion in costs, with most of those savings occurring over the next three years and the rest over the following two years. Levin stated that the savings will come from every aspect of its business, including the way it procures raw materials, the amount of real estate it owns, and how it invests in information technology.

It also plans to develop what Levin referred to as "new therapeutic entities," or NTEs, which would include new formulations, new ways to deliver drugs or new combinations of existing products. Michael Hayden, founder of biotech company Xenon Pharmaceuticals and now Teva's chief scientific officer, said going this route should bring more bang for the buck than developing new molecules, Reuters reported. The company has a goal of approving 15 of these next year and getting them to market by 2016.

TEVA Can Benefit From Its Competitors Patent Expirations

There are both winners and losers when patents expire. While there's fear that TEVA will lose income through the expiration of its Copaxone patent in 2015, its competitors are losing patent protection on a host of blockbuster drugs. As the worlds largest generic drug manufacturer, TEVA could surely benefit from some of the patent expirations listed below that fall within it's production and marketing plans:

Competitor Patent Expirations
Drug2012 SalesExpirationCompany
Cymbalta$4.9 Billion2013Eli Lilly
Avonex$2.9 Billion2013Biogen Idec
Humalog$2.5 Billion2013Eli Lilly
Plavix$5.2 Billion2012Bristol-Myers
Seroquel$4.2 Billion2012AstraZeneca
Singulair$3.5 Billion2012Merck
Actos$3.1 Billion2012Takeda
Lexapro$2.4 Billion2012Foest

Here are TEVA's basic metrics:

MetricFactor/Number
Closing Price 1/29/2013$37.35
PE Ratio6.64
Annual Dividend Per Share$1.03
Next Ex-Dividend Date02/13/13
Effective Yield2.75%
52 Week High$46.65
52 Week Low$36.63
Beta0.73
5 Year Growth Rate18.81%
Current Year Est. EPS$5.09
Next Year Est. EPS$5.60
Compiled by Craig Van Pelt
SOURCE: Scottrade

Conclusion

The time to buy a stock is when its down and out of favor, and that surely describes TEVA. In my view, its upside potential is enormous. With a PE of roughly HALF of the industry sector, the risk/rewards are in the favor of investors who act now. The negatives have already been discounted. In the meantime, collecting a 2.75% dividend adds to its attractiveness. I'm long TEVA and expect to add to my position.

Source: Teva Pharmaceuticals: Beaten, Bludgeoned And Brutalized - It's A Buy