A study released by the IMS Institute for Health Informatics finds that per capita spending on medicines declined by $33 in 2012. On one side, the report raises the question of whether this is good or bad. Is it due to better utilization of healthcare resources, or does it signify "under-treatment and an imbalance between prevention and care"? On the other side, it tries to understand the drivers to the decline. Considering the role of generic drugs as expressed in the report and in light of the patent cliff, this article tries to make a case for investment in one of the largest generic drug manufacturers, Teva Pharmaceutical (NASDAQ:TEVA).
The IMS Report
One of the key findings relates to lower utilization of branded drugs, which, as per the report, was primarily due to:
- increased availability of generic drugs
- price increases
- lower spending on newly launched drugs
Teva Pharmaceutical is an Israel-based global company engaged in the production and marketing of generic drugs across a range of treatment categories. Along with generic medicines, the company's product portfolio includes branded pharmaceutical products, the most important among them being Copaxone for multiple sclerosis, Azilect for Parkinson's disease, and Provigil and Nuvigil for excessive sleepiness, sleep apnea, and shift work disorders.
- Dismal first quarter 2013
Q1 2013 earnings, although poor, were in line with market expectations. Against a forecast of $1.1 per share, the company reported EPS of $1.2. However, there was a decline in almost all financial parameters -- net revenue by 4%, operating income by 6%, net income by 27%, and diluted EPS by 32% as compared to the same quarter in the prior year.
- Bad, but not that bad
Most of it is attributed to adjustments of $330 million on account of one-time expenses and weakening of the yen and some Latin American currencies against the U.S. dollar. Moreover, Q1 2012 was marked by the launch of generic version of Zyprexa (olanzapine), the atypical antipsychotic drug of Eli Lilly (NYSE:LLY) and the agreement with Ranbaxy regarding the launch of generic version of Pfizer's (NYSE:PFE) blockbuster drug, Lipitor.
In addition, the company was able to maintain revenue of its specialty business ($2.1 billion) despite losing exclusivity on Provigil due to patent expiry in April 2012. On the other hand, sales of the company's over-the-counter product line jumped 56% to $306 million. Despite the loss of exclusivity of Provigil, a highly profitable business, profit margin dropped by only 2.3% -- from 60.9% to 58.6%.
- Uncertain future
Sales of Copaxone, the company's primary specialty drug for treating multiple sclerosis (MS) amounted to $3.6 billion, approximately 20% of the company's total revenue. The patent on Copaxone expires in 2015. Besides the threat from generic versions of Copaxone, the company also has to cope with the onslaught from alternative new MS drugs from competitors, including Novartis (NYSE:NVS) and Biogen Idec (NASDAQ:BIIB).
Down, but Not Out
- On Copaxone patent expiry
Copaxone has an advantage over competitors inasmuch as it is a first-line drug. Alternative drugs are prescribed only after a patient does not respond to Copaxone. As far as the generic threat is concerned, any generic version may be approved by the FDA only after fresh clinical trials due to the specific chemical properties of glatiramer acetate, the active ingredient of Copaxone. In addition, the company reported positive data on Phase III clinical trials of high dose Copaxone, which will allow a three times weekly dose rather than daily. It is now hoping that it is approved by the U.S. FDA in early 2014 before the threat from generic versions becomes a reality.
- The overall industry scenario
The environment in which Teva Pharmaceutical operates is generally conducive to growth. The worldwide market for generic drugs is expected to grow at 7.8% CAGR. Additionally, tightening healthcare budgets are likely to put pricing pressure on branded drugs, whereas generics have no such pressures as they compete solely on price. Of particular mention here is an article based on data and inputs from IMS National Prescription Audit PLUS, Thomson Reuters Fundamentals via FactSet Research Systems, and Bloomberg.
There is a decline in number of prescriptions sold by the branded drug manufacturers including Novartis, Pfizer, AstraZeneca, GlaxoSmithKline, and Eli Lilly. However, this does not reflect in their revenue because these companies are selling more higher-priced drugs. A classic case is that of Pfizer's Lipitor. Lipitor, the company's blockbuster drug for lowering cholesterol was its bestselling drug until expiry of its patent. Pfizer's top-selling drug is now Lyrica (pregabalin), an anticonvulsant used for neuropathic pain.
Companies such as like Merck and Eli Lilly that sell only branded drugs have per prescription cost of more than $250. For Novartis, which has a portfolio of branded as well as generic drugs it is $74. The same figure for Teva Pharmaceutical, primarily a generic drug maker with an equally impressive portfolio of branded products, is $18. For Dr. Reddy's Laboratories, an Indian generic drug manufacturer, the cost per prescription is even lower at $9. The industry is undergoing a dynamic change. Revenue loss from patent expiration from now and 2018 is likely to be in the range of $290 billion. Once the process of change is completed, it will be generics and not branded products that are likely to dominate the market.
Last year we saw the largest ever impact of patent expirations, or what has come to be known as the patent cliff. Drug companies whose patents expired in 2012 collectively suffered a revenue loss amounting to $28.9 billion, meaning that there is that much more on the table for manufacturers of generics. In 2013, the revenue loss on account of patent expiry is expected to be in the range of $29 billion.
Teva Pharmaceutical is an ideal mix -- a market leader in generics (fast-growth segment) and No. 11 in branded drugs (high margin) market. The uncertainty over Copaxone patent expiration is probably the reason why the company's stock got battered in the last 12 months. However, the company is on track with getting FDA approval for higher dose Copaxone. Moreover, although not in the business of discovering new drugs, Teva Pharmaceutical has a long-standing relationship with Israel's Weitzman Institute from which it acquired Copaxone.
Teva Pharmaceutical figures in UBS's list of global dividend ruler stocks to buy with a consensus target of $43. The stock was recently trading at $38.87 and has a dividend yield of 2.92%. I would go by this recommendation and buy Teva now, and also at every substantial dip to accumulate for the long haul.
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.