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I am sure many of us have had to face the exorbitant cost of healthcare over the last few years, either in the form of high insurance premiums, expensive drugs or seemingly endless tests on highly sophisticated equipment. While the quality of care is excellent (in most cases), the cost is usually appalling. These high costs generally translate into excellent profit margins for companies that operate (pun intended) in the healthcare sector.

Before deciding to buy Pfizer for my personal portfolio and featuring it on SINLetter, I talked to a friend who has years of experience in the pharmaceutical industry. Late last year stocks of big pharmaceutical companies like Pfizer (NYSE:PFE) and Merck (NYSE:MRK) were trading at their lowest level in five years. These stocks were battered thanks to the triple threat of competition from biotechs, a large number of lawsuits and a record number of patent expirations in 2006.

My friend suggested that instead of Pfizer, I explore two other companies called Teva Pharmaceutical (NYSE:TEVA) and Mylan Laboratories (NASDAQ:MYL). When I looked them up, I realized that they were companies that made low cost generic versions of big pharma drugs after their patent expires. However Wall Street was very well tuned into the fact that the generic drug companies stood to benefit from the record number of patent expirations 2006 and had bid up the price of companies like Teva by 45.26% in 2005. I decided to put Teva and Mylan on my watch list and picked up Pfizer instead in December 2005. Fast-forward 8 months. Since the beginning of this year Pfizer has gained 23.33% while Teva has lost 18.01%, just as it is beginning to profit from those patent expirations that Wall Street was so tuned into last year. For a complete list of generic drug approvals by year and month, check out this page on the U.S. Food and Drug Administration [FDA] website.

Israel based Teva Pharmaceutical is one of the largest generic drug manufacturers in the world with 2005 revenue of $5.25 billion and over a billion dollars in earnings. Teva currently has an 11% share of the US pharmaceutical market with sales of $393 million from 326 different drugs. For the second quarter of 2006, sales were up by 77%, while earnings were up an amazing 83% and gross profit margins improved to 53.9%. These numbers may not be surprising for a fast growing young company, but Teva is a company with $5.25 billion in annual sales and went public in 1991. Second quarter earnings per share of 66 cents beat analyst expectations by almost 44%.

The drop in Teva's price in 2006 is largely driven by the fact that Wall Street looks at future earnings and analysts currently believe that 2007 earnings for Teva may not be as good as 2006 earnings. According to Israeli journalist Shlomo Greenberg, Wall Street analysts are mistaken about 2007 earnings and you can read about it in his article here. Teva recently revealed that it has 148 more applications for generic drugs filed with the FDA and has over 1,000 applications pending approval in Europe (Source: Standard & Poor's). Based on the number of applications and the fact that Teva's proprietary drug Azilect for Parkinson's disease will contribute to revenue growth in 2006 and 2007, I believe that Wall Street analysts are probably mistaken about Teva's future prospects making it an excellent investment at this time.

Competitors:
Teva competes against big pharma companies like Pfizer (PFE), Merck (MRK), GlaxoSmithKline (NYSE:GSK) and Novartis (NYSE:NVS). Teva Pharmaceutical also competes with other generic drug companies like India based Ranbaxy and Dr. Reddy's Laboratories (NYSE:RDY), US based Mylan Laboratories (MYL) and Canada based Apotex.

The Good:

  • Teva stands to benefit from the new medicare plan that encourages users to opt for cheaper generic drugs.
  • Teva is benefiting from the record number of patent expirations in 2006 and in some cases has a six month exclusive right to manufacture the generic versions.
  • Teva is currently awaiting the results of an FDA appeal that will allow it to exclusively manufacture the generic version of the blockbuster cholesterol drug Zocor for 180 days.
  • Second quarter 2006 sales and earnings were significantly higher with improving gross margins.
  • Teva's acquisition of generic drug manufacturer Ivax Corp earlier this year was considered a good move by analysts.
  • As of 2005, Teva had a strong balance sheet with more than twice the total assets as total liabilities.

  • The Bad:

  • It goes without saying that turmoil in the Middle East is a risk to all Israeli companies.
  • In an ironic twist, Teva faces competition from big pharma companies like Pfizer and Merck who are rolling out their own generic versions or in some case significantly dropping prices of drugs that are no longer protected by patents.
  • Teva also faces increased competition from other generic drug companies like Barr Laboratories, Ranbaxy, Dr Reddy's, Mylan and Apotex.
  • As of 2005, Teva carried a large amount of Goodwill on its balance sheet ($2.46 billion). In early 2006, it also issued more debt to pay for the Ivax acquisition.

  • The Numbers:

  • P/S 4.08
  • P/E 417.26
  • Cash $1.28 billion
  • Long Term Debt $1.77 billion
  • Source: The Long Case for Teva Pharmaceutical