Teva's Bad News Presents Buying Opportunity

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Includes: BIIB, MYL, NVS, TEVA
by: Analytical Chemist

Teva’s (NASDAQ:TEVA) stock price fell 8.5% on Friday after competitor Biogen Idec (NASDAQ:BIIB) reported favorable results from one of its Phase 3 trials. Biogen Idec’s BG-12 and Teva’s Laquinimod are both oral multiple sclerosis (MS) treatment drugs in Phase 3 trials—the last step before seeking FDA approval. Biogen Idec’s report suggests that BG-12 is more effective. While the market took Biogen’s news as a setback for Teva, I find Teva’s prospects not significantly changed. It is the world leader in generic drugs, with a history of fast growth and good growth prospects ahead. With such bright prospects, I view this price decline as a buying opportunity.

Two measures of the effectiveness of MS treatments are the annual relapse rate and the reduction in disability progression. Biogen Idec’s BG-12 showed an annual relapse rate of 53% and a reduction in disability progression of 38%. Teva’s Laquinimod showed annual relapse rate reduction of 23% and disability progression reduction of 36%. While both BG-12 and Laquinimod lag behind Novartis’ (NYSE:NVS) Gilenya, which is already on the market, Laquinimod is closer to market than BG-12. Effectiveness and time on market both determine sales of drugs, due in part to doctors’ and patients’ familiarity with existing treatments and unwillingness to switch if their current treatment is working. Gilenya, Laquinimod, and BG-12 are likely to share the market. Even if Laquinimod gets a smaller piece of the market than previously hoped, it will still have a seat at the table, and Teva’s prospects in the rest of its businesses are poised to compensate.

Teva is the world’s largest manufacturer of generic drugs. Seventy percent of all prescriptions in the United States are for generics, and Teva’s generic drugs accounted for 21% of all U.S. generic prescriptions in 2010. Current and upcoming patent cliffs for branded pharmaceutical companies represent enormous potential for increased sales and profits for generic drug manufacturers.

In 2010, Teva began selling generic versions of 18 drugs including Flomax, Valtrex, and Effexor, each of which had prior year sales of more than $2 billion. Teva also received 21 final generic drug approvals and 14 tentative approvals in 2010. Tentative approvals are those for which final FDA approval is expected once the branded drug patent expires or other regulatory or exclusivity periods end. These 14 tentative approvals included generic versions of one-billion-dollar drugs Namenda, Crestor and Aricept. This pipeline should continue to grow; as of February 2011, Teva had 206 product registrations awaiting FDA approval including 44 tentative approvals. Teva was the first company to file in 80 of these registrations, suggesting that Teva is able to take advantage of its size advantage to get more of the lucrative 180-day exclusivity from being the first to file.

Teva also has a significant business in branded drugs. Its branded drugs, biosimilars, and women’s health products accounted for about 30% of 2010 sales. Copaxone, its bestselling drug and market leader in MS treatment, was responsible for 18% of net sales in 2010, and has higher margins than Teva’s generic drugs. Copaxone faces patent expiration in 2014, and is currently facing patent challenges from both Sandoz, a unit of Novartis (NVS), and Mylan (NASDAQ:MYL). The district court hearing these cases denied a summary judgment for Sandoz. These two cases will be combined and tried together with a trial date of September 7, 2011.

Even if Teva preserves its patent, the patent only runs through 2014. However, Copaxone is not a typical drug of which the exact molecular structure is known, but rather is a mixture of many molecules of 4 different chemicals that combine in a random way until it reaches a certain size. This makes it significantly more difficult for a generic version to gain FDA approval. Instead of demonstrating through analytical techniques that generic versions are chemically the same (as is done for small molecule generics), generic versions of Copaxone may have to conduct clinical trials to show the same clinical effectiveness. The FDA already elected not to approve a formulation change of Copaxone that was submitted last year. This formulation change consisted merely of supplying the same amount of the drug in half the injection volume. If even a change in the concentration of the injection would require an efficacy study, it is likely that generic versions of Copaxone will require clinical trials. This would be bad for Mylan and Sandoz; it would be very good for Teva.

Teva both enjoys advantages and suffers disadvantages of geographic diversification. 60% of operating costs in 2010 were incurred in non-U.S. currencies, principally the Euro but also including the Israeli shekel, Hungarian forint, Canadian dollar and British pound. North America accounted for 60% of sales; the European Union, 25%; and other regions, including Latin American, Israel, Russia, and non-EU Eastern European nations, 15%. Changes in exchange rates could materially help or materially hurt Teva’s profits. Its expansion in Latin America, Russia and Eastern Europe expose it to emerging markets and the potential growth found therein.

Teva has increased its dividend each year for the last 10 years. While the current dividend is just 1.7%, it has grown at a 26% annual rate over the last 5 years and should continue to grow as Teva’s payout ratio is still below 20%.

The management of Teva is strong and it has developed a comprehensive plan for sales and earnings growth. It released a plan in 2010, to effectively double sales and earnings between 2010 and 2015. It plans to do so through expansion of market share, introduction of new generic products, research and development of branded products, and geographic expansion into countries with low generic penetration rates. Analysts find that Teva is on track to do this. Zack’s consensus estimate for 2011earnings is $5.07, and $5.73 for 2012. Zack’s estimate of earnings growth for the next 5 years is 12% annually, and Value Line is even more optimistic.

While it is unlikely that Teva will be able to duplicate its 22% annual increase in earnings over the last 5 years, both Teva and analysts agree that 12%-15% growth over the next 5 years is achievable. When this earnings growth is combined with an incredibly low P/E of 10 on trailing earnings and 9 on estimated 2011 earnings, Teva looks like a great company at a great price. That Teva has increased its dividend each year for the past 10 years and at a 26% annual rate over the last five is icing on the generic cake. The current dividend of 1.7% should continue to grow with Teva’s payout ratio still below 20%. Teva should be good for your financial health – buy two and call me in the morning.

Disclosure: I am long TEVA.