Teva Pharmaceuticals: Copaxone's Upcoming Expiration Continues To Depress Its Current Valuation

Oct.29.13 | About: Teva Pharmaceutical (TEVA)

Shares of Teva Pharmaceuticals (NYSE:TEVA) saw a modest jump upwards at the end of last week after the pharmaceutical company received some positive comments from analysts at Citigroup.

While the expiration of Copaxone will still be painful, Teva has already reduced its reliance on the drug, and has taken measures to reduce operating costs, while focusing on replenishing its pipeline.

I agree with Citigroup and am cautiously optimistic for the long term.

Citigroup Is Getting Bullish

Analysts at Citigroup (NYSE:C) initiated a "Buy" for Teva accompanied by a $47 price target. This suggests shares have some 17% upside from Thursday's closing levels.

Analyst Liav Abraham sees potential to unlock value in the coming year, as investors will look past the Copaxone expiration cliff to focus on the growth profile of Teva excluding Copaxone.

These activities have seen 19% CAGR growth over the past five years, while Citigroup sees further potential for shareholder friendly actions.

Valuation

Teva ended its second quarter with $1.25 billion in cash and equivalents. The company operates with $12.46 billion in total debt, for a net debt position of around $11.2 billion.

Revenues for the first six months of the year came in at $9.82 billion, down 2.7% Y/Y. Net profits fell from $1.72 billion to $178 million on the back of $1.62 billion in settlement, impairment and restructuring charges. At this pace, revenues for the full year could come in around the $20 billion mark as guided by Teva. Non-GAAP earnings are seen between $4.85 and $5.15 per share, or around $4.7 billion.

Trading around $41 per share, the market values Teva at $39 billion. This values equity in the firm at 2.0 times annual revenues and 8-9 times annual earnings.

Teva currently pays a quarterly dividend of $0.322 per share, for an annual dividend yield of 3.1%.

Some Historical Perspective

Over the past decade investors in Teva have seen modest returns. Shares steadily doubled between 2004 and 2010, increasing from $30 to $60.

After shares peaked in their mid-sixties in 2010, driven by the success of Copaxone, shares have fallen back some 35% to levels around $40 per share at the moment.

Driven by Copaxone sales, Teva has increased its annual revenues by a cumulative 46% to $20.3 billion. Net earnings came in around $2 billion after peaking at $3.3 billion in 2011.

Investment Thesis

Teva's biggest problem is the reliance on Copaxone, with a patent expiration coming soon.

That being said, Copaxone makes up roughly 22% of Teva's total revenues, coming in around $1.1 billion over the past quarter. This means that Copaxone makes up roughly half of total specialty revenues of $2.1 billion over the past quarter. Note that Teva still generated $2.4 billion in generic drug revenues over the past quarter, making it the world's largest generic drug producer.

To offset some of the pain for shareholders, Teva is trying to please its shareholders. The hiked dividend boosted the dividend yield to 2.9%. Add to that the $300 million pace of share repurchases over the past quarter. This implies that Teva returns cash flows at a rate of another 3% per year through repurchases, for combined returns to shareholders of 6%.

Note that Teva still operates with quite a lot of debt, some $11 billion, net of cash. As such, unlike Citigroup I don't see how Teva has the potential to boost cash flows to shareholders without hurting the balance sheet even more.

To offset the impact of the expiration of Copaxone, Teva is boosting its cost cutting efforts. It now aims to save $2.0 billion in costs by 2017, including $1.0 billion by the end of 2014 through reducing its workforce by 10%. A large portion of these savings will be reinvested in high-potential programs in the development of complex generics, including more than 30 late-stage programs. Note that total restructuring costs are estimated around $1.1 billion.

As such Teva is struggling somewhat going forwards. The $20 billion revenues and $4.7 billion in non-GAAP earnings will take a large toll on the back of lost sales of Copaxone as the drug see its patent expire next year, putting $4 billion of revenues at risk. Note that nearly $2 billion in cost savings and an increased generics pipeline have the potential to overcome a lot of the expiration inflicted wounds.

As such Teva looks quite appealing based on its current valuation. There are two problems however in my opinion. The structural nature of restructuring and legal expenses, which is inherent to Teva's focus on generics, makes me hesitant to use non-GAAP earnings metrics. The other thing I don't like is the relative high debt position.

Back in November of 2012, I last took a look at Teva's prospects. At the time, shares traded around $40 per share as I concluded the valuation was too depressed on worries about Copaxone.

At the time I concluded that shares might be appealing given the expected gradual slowdown of Copaxone revenues in 2015 and beyond. The fact that the pipeline is filling up again, through targeted R&D investments, combined with cost control efforts, makes me slightly more upbeat. Also note that Copaxone is important, being the top-selling drug, but revenues made up 22% of firmwide revenues, a number which Teva should be able to deal with.

There might still be room for upside potential in the medium to short term, although the net debt position is still rather high, as I would like to see the gap between GAAP and non-GAAP earnings narrow, through a reduction in one-time expenses.

All in all, I remain cautiously optimistic for the long-term prospects.

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.