With an aging U.S. population and the government trying to reduce the costs of various national health care programs, generic pharmaceutical firms such as Teva Pharmaceutical Industries (NASDAQ:TEVA) are primed to benefit substantially. Teva isn’t a new name, but with strong growth prospects lying ahead, this isn’t an old dog either.
Now some might believe that access to an aging U.S. population would be a sufficient growth catalyst, but we disagree; because that would be setting the bar too low for the health care space. When we look at companies in this sector, we try to find the firm that has a roaring fire in its belly and is hell bent on maximizing every opportunity to grow without taking on excessive risk. We believe that Teva fits that mold and we rate it a buy based on multiple growth opportunities, industry leading status, and strong economies of scale.
The sun may set In the west but new opportunity lies in the east
Firm management has made it clear that is has no intention of slowing down in relation to growth and wants to drive the company like a Formula One racecar. Growth prospects for Teva stem from both internal R&D and from acquisitions, but what matters the most is that the numbers make sense. Given that Teva has had some recent acquisition activity, we’ll focus on this part of the firm’s growth strategy first.
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Teva’s most recent acquisition of Taiyo Pharmaceutical (57% controlling stake), which is based in Japan, illustrates the firm’s accretive acquisition strategy and its focus on geographic market diversification. As a country, Japan is the second-largest pharmaceutical market in the world. Even better, generic drug utilization in Japan is below 25% while it’s almost 70% in other parts of the developed world. There is no question that growth opportunity lies in the East and Teva is aggressively pursuing this reality.
The firm looks to have paid a reasonable price for Taiyo Pharmaceutical at $460M since it had roughly $530M in sales for 2010. It’s also likely that Teva will make an offer to acquire the remaining minority stake and thereby gain full ownership. When all is said and done, Teva will be accessing one of the top markets with substantial growth opportunities and doubling its sales numbers in Japan. Looking ahead, we see Teva’s acquisition strategy continuing to be successful in relation to execution, increasing firm value, and accessing new areas for growth.
Industry Titan For a Reason
Currently Teva is an industry leader in its space. This position has been gained by consistently outmaneuvering competitors, holding a long history of successful acquisitions, and building upon its prior success quickly. The result of all this is a hybrid firm that offers both generics and branded pharmaceuticals.
The development of branded pharmaceuticals on top of generics has been a critical step in breaking out of the pack. This is due to the fact that by offering both generics and branded pharmaceuticals, the firm has been able to increase its return on total capital to an even greater level. If it focused on generics alone, it wouldn’t be able to achieve the numbers it does today and this in our opinion is a great X-Factor.
The firm stands to continue holding its industry leading position by producing top generics, having 15 different products under development, and waiting for new U.S. patents to expire on other drugs. This reality allows the firm to remain more diversified than competitors and nimble by only pursuing opportunities that offer the best relative value, be they generics or branded drugs.
The firm has built an economic moat due to its strong economies of scale. This economic moat is primarily founded upon the firm’s low cost operations and vertical integration. Other firms such as Procter & Gamble (NYSE:PG) have taken notice as well. Currently, Teva and Procter & Gamble have a joint venture that focuses on developing over-the-counter branded pharmaceuticals given the firm’s inherent strengths. In our opinion, by holding a strong position like this, the firm can essentially limit the entrance of new low-cost producers that may attempt to compete with it.
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Teva operates with the highest return on capital and profit margins in the industry. This means that when many lucrative U.S. patents expire in 2013, the firm can leverage its economies of scale, stay focused on the best opportunities and not have to slow down in order to build out new infrastructure. To us this sounds like an amazing recipe for success.
Teva Pharmaceuticals is clearly more than just a generic drug maker. It’s a hybrid pharmaceutical firm that operates on both sides of the fence when it comes to generics and branded drugs. Does the firm throw around its weight? Definitely, and we like that because we’re in the business of hunting for great companies such as Teva.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.