Teva Pharmaceutical (TEVA) used to be the golden boy of the diversified pharmaceuticals industry due to its dominance of the generic pharmaceuticals segment. Unfortunately for TEVA, it became too dependent on acquisitions under its former CEO and former Israeli Army apparatchik Shlomo Yanai and its acquisition spree ended up creating much operational inefficiency. Despite its stumbles under the previous CEO, TEVA is still the industry leader in the generic drug segment and it is emerging as a major branded pharmaceuticals company in its own right. Although we were hoping that TEVA's performance trajectory would have shown a faster recovery under former Bristol-Myers Squibb (BMY) Senior Vice President Dr. Jeremy Levin than what has occurred, we're willing to give his strategic and realignment strategy time to work out. We believe that TEVA's share price is near a bottom for the following reasons:
- TEVA's share price is within 5.75% of its 52-week low
- TEVA's share price has declined at a narrower rate (-3.8%) than the S&P 500 (-6.06%) since the market peaked on May 22
- TEVA's adjusted PE is 7.7X and this is much less than its major pharmaceutical peers
- Despite TEVA's stumbles, it has still generated $1.7B in reported profits over the last 12 months even with a recurring number of "non-recurring issues".
- TEVA still earned more net profits in the last 12 months than its four biggest competitors (Perrigo (PRGO), Forest Labs (FRX), Mylan (MYL) and Actavis (ACT)) put together and yet is trading at an adjusted PE ratio well below those companies.
Source: Morningstar Direct
Despite the fact that TEVA's Q1 results beat expectations, its revenues and EPS were soft in Q1 2013 as the company saw revenue declines from its US generics franchise. The company saw its Q1 2013 revenues decrease by 4% due to lower royalties related to the sales of the generic equivalent of Lipitor® (atorvastatin) under its agreement with Ranbaxy, a decline in sales of mixed amphetamine salts ER due to increased competition and a decline in sales of escitalopram, for which TEVA had exclusive rights in the first quarter of 2012. TEVA also generated $836 million in free cash flows for the first three months of 2013 and used that cash as well as a portion of its existing cash stash to buy back $200M worth of stock, pay $281M in dividends, pay down $1.8B of debt and it still has $1.4B in cash equivalents as of Q1 2013.
Source: Morningstar Direct
With regards to legal issues surrounding TEVA, the company recently settled a lawsuit related to creating a generic version of Pfizer's Protonix acid-reflux drug that was an "at-risk launch". A New Jersey jury ruled that TEVA had infringed the Protonix patent in April 2010, following a protracted 10-year legal battle. A trial to determine damages began on Monday, June 10th and TEVA decided to settle two days later. TEVA took a $670M loss contingency provision relating to the case in FY 2012 and another $930M in its upcoming Q2 2013 reported results. We agree with Bernstein Research analyst Aaron Gal when he said "The Protonix damages were one of the negatives TEVA had to 'get out of the way' before investors can focus on the company's growth prospects." Separately, TEVA reported positive results from a mid-stage study of its experimental lupus drug that aims to treat inflammation of the kidney caused by the autoimmune disorder. The study showed that the drug when combined with mycophenolate mofetil and corticosteroids - the current standard of care - improved kidney function compared with current therapy alone.
Copaxone's quarterly revenue reached $1.06B during the quarter, up from $909M in Q1 2012. The US accounted for 76% of Copaxone's revenue during the first three months of 2013, up from 66% during the first three months of 2012. Copaxone's market share is still above 38.2% and we agree with TEVA's management that it should maintain its global market leadership position due to its established and clinical experience in treating RRMS patients. TEVA continues to consider and develop ways to enhance patient experience with Copaxone through a very vigorous life cycle management program.
Adjusted EPS for the Q1 2013 period was $1.12, which beat analyst expectations by $0.02 but was 24% lower than the comparable period last year. The company took $107M in charges in Q1 2013, down from $255M in Q1 2012. TEVA reiterated its FY2013 guidance in February and it announced the sale of its Irvine, California manufacturing plant. According to TEVA's CEO Jeremy Levin, the company is looking for a buyer "with a strategic long-term interest in the facility" that will manufacture for TEVA until it can move the products to other locations. The Irvine plant has fallen on hard times in recent years, encountering some quality control problems that led to the temporary suspension of production and distribution, followed by layoffs. The factory currently employs about 400 people, roughly half the number who worked there in 2010.
One bright spot for TEVA is its over-the-counter healthcare products joint venture partnership with Procter & Gamble (PG). Net revenues from OTC operations in Q1 2013 were $306M, an increase of $110M (56%), compared to $196M in the first quarter of 2012. This increase was mainly due to a strong flu season in Europe and Eastern Europe and an overall increase in all product categories. In addition, as of December 2012, the OTC products of Cephalon (Mepha) were included in the PGT joint venture. TEVA's revenues related to PGT amounted to $240 million, an increase of 47%, compared to $163 million in the comparable quarter of 2012.
PGT's in-market sales for the first quarter of 2013 amounted to $409 million. This amount represents sales of the combined OTC portfolios of TEVA and P&G outside North America. Sales grew in Europe, Eastern Europe and Latin America, mainly due to the factors noted above, while sales in Asia were flat. Revenues from the sales of OTC products in the United States to P&G, which commenced in the fourth quarter of 2011 pursuant to a manufacturing agreement, amounted to $66 million in the first quarter of 2013, compared to $33 million in first quarter of 2012.
In conclusion, we at Saibus Research added to our long position in TEVA in Q2 2012 due to its dirt-cheap price relative to its intrinsic value as well as relief from its patent-infringement victory on Saturday, June 23. We believe that the company is taking steps to restore its culture of operational excellence. In our August 14th report, we saw that it had a lower PE than the largest major pharmaceutical companies and it had better growth prospects. We think a 7.7X 2013 adjusted EPS is an insanely dirt-cheap price for the industry leader in generic pharmaceuticals, especially when said industry leader upgrades its executive leadership team. TEVA generated $3B in average annual free cash flows from 2008 to 2012 despite possessing poor management for most of that period. TEVA also repurchased $1.5B in stock over the last 7 quarters. TEVA also announced a 3 year, $3B share repurchase program in December 2011 and has repurchased $1.37B under the program. We also like to say that while Teva Pharmaceutical has yet not restored the excellence in execution we saw under Hurvitz and Israel Makov, at least it isn't Forest Laboratories.
Additional disclosure: This article was written by an analyst at Saibus Research. Saibus Research has not received compensation directly or indirectly for expressing the recommendation in this article. We have no business relationship with any company whose stock is mentioned in this article. Under no circumstances must this report be considered an offer to buy, sell, subscribe for or trade securities or other instruments.