To the credit of Teva Pharmaceuticals' (TEVA) board, if you underperform in the top spot there, you will be replaced. Recent years have seen the company struggle to deliver the sort of performance that shareholders had come to expect, and missteps in manufacturing and clinical development didn't help matters. Now the company has a new CEO, strong generic candidates, a growing branded business, and perhaps a chance to regain past esteem.
A Fairly Solid Q4
Teva's fourth quarter results were solid, if not radically ahead of expectations. Revenue rose about 29% as reported, with the inclusion of Cephalon adding a significant amount of revenue growth. Revenue from generic drugs and ingredients rose 12% overall, but were down 5% in the U.S. Branded drug sales rose 68% as reported or about 25% on an organic basis, with Teva's key multiple sclerosis drug Copaxone up 11%.
Profitability was good on an adjusted basis. Reported gross margin and operating income were down on costs primarily related to Cephalon. Adjusted gross margin rose about a point, while operating income increased about 34%.
Promising Opportunities In Generics … For Now
As the negative year on year comp in U.S. generics may suggest, Teva's generics business has not been in top form lately. Competition from Watson (WPI), Mylan (MYL), and Novartis (NVS) gets some blame, but so does company-specific missteps - highlighted, perhaps, by the company's problems in launching a generic form of Abbott Labs' (ABT) Tricor.
The good news for investors is that there are plenty of big fish swimming toward Teva's nets. Forest's (FRX) Lexapro could be worth hundreds of millions, as could a generic of Pfizer's (PFE) Lipitor. Other major drugs like Actos (Takeda), Plavix (Bristol-Myers Squibb (BMY) and Sanofi (SNY)), and Seroquel (AstraZeneca (AZN)) could also be significant eventual contributors to Teva's sales and profit base.
One concern to consider is that the pipeline may be narrowing a bit in the U.S. Most major pharmaceutical companies are past the worst of their patent expirations and though some major drugs do come off patent in the next few years, the overall pickings aren't as ripe as they were a few years ago. Teva can partially offset this with more foreign sales, but it's a concern all the same.
Biosimilars Could Be A Boon
The FDA recently released guidelines for companies looking to develop biosimilars (basically generic versions of biologic drugs) and the guidelines were pretty favorable to companies like Teva. Teva has an alliance with Swiss company Lonza to develop biosimilars (not unlike the alliances between Watson and Amgen (AMGN) or Mylan and India's Natco) and the potential sales from generic versions of drugs like Abbott's Humira, Amgen's Enbrel, or Sanofi's Lantus could be significant.
Count on a lot more wrangling over the biosimilar issue, but the reality is that they're coming and they could go a long way towards recharging Teva's off-brand business.
Sorting Out The Branded Business
If Teva's generics/biosimilars opportunities are looking better, the same is not necessarily true for the branded side. Teva is fighting hard to stave off generic versions of Copaxone, but there is nevertheless a clear risk from oral compounds from Novartis (Gilenya), Biogen Idec (BIIB) (BG-12) and Sanofi (Lemtrada). While docs are reticent to shift patients away from MS therapies that are working, it stands to reason that these alternatives will at least get tested out.
Elsewhere in the pipeline, Teva is looking for good results from Nuvigil in bipolar disorder to support a follow-on indication with this drug. Behind this, the company does have an evolving franchise in respiratory care and cancer (as well as a compound for celiac disease), but not necessarily a clear blockbuster at this point.
Will New Management Commit More To New Ventures?
Teva has built itself into a pretty sizable player in the fragmented generics space, but the active shopping on the part of other generic companies and Big Pharma players like Sanofi and Novartis has left relatively few clear targets. That being the case, management has talked about doing some additional "moderately sized" deals and expanding the branded and OTC businesses could be logical extensions.
The Bottom Line
Even for all of the setbacks and disappointments of the last couple of years, Teva remains a very profitable company with good distribution and upside from its expansion into branded drugs. The company will clearly have to manage the threat to its MS franchise, but investors should not focus on the threats to the extent of losing sight of opportunities like biosimilars.
I expect very little from Teva over the next decade (low single-digit free cash flow growth), but that very modest expectation is enough to drive a price target in the high $50's. Teva is arguably riskier than plays like Abbott or Sanofi, and inarguably pays a lower dividend, but meaningful undervaluation on low expectations sounds like a good situation for investors with a value or turnaround inclination.