There's no question that Teva Pharmaceuticals (TEVA) rewarded long-term investors with years and years of growth as it became the world's largest generic drug manufacturer. The biopharma world has changed, though, and so has Teva. Now branded companies like Novartis (NVS) and Sanofi (SNY) are in generics, and generic companies like Teva are in branded drugs. And just for good measure, a few outliers like Endo Pharmaceuticals (ENDP) add devices to the mix, while others like Abbott (ABT) and Covidien (COV) look to split and spin-off their drug businesses.
What's the point? Well, mostly that Teva probably has to start thinking more and more like Big Pharma if they want to continue to grow the business. It's hard to imagine that there's much buying left to do in the generic space (apart, perhaps, from a few select deals in specific markets), but there's plenty that the company could do in terms of buying branded drug/biotech businesses, or in-licensing compounds. Given the expense control management is showing, the synergy potentials alone could make M&A a viable path to growth.
Mixed Messages In Q1
While most pharmaceutical companies did okay revenue-wise this quarter, Teva did not. Revenue grew 25% as reported, but still missed the consensus number by a large (7%) margin. As has been seen in other Big Pharma reports, Europe was the culprit as aggressive cost-containment moves took their toll.
Overall, generics revenue rose 12%, with sales in the U.S. climbing 29% and Europe declining 12%. Branded sales were up 54% as reported, with 8% growth in Copaxone.
Where Teva shined was in an area that I do not believe most investors are accustomed to looking for exceptional out-performance - expense items. Gross margin improved more than a point, and operating income jumped 42% on a four point improvement in operating margin. If Teva were a regular Big Pharma company like Pfizer (PFE) or Lilly (LLY), I dare say many analysts would have cheered the earnings and pointed toward the excellent cost control.
The MS Market Still Far From Sorted Out
The goings-on in the MS market continue to drive a lot of the sentiment on Teva, and given that Copaxone is almost 20% of sales that makes sense. Although there have been some safety concerns regarding Novartis' drug Gilenya, the recent revision to the label seems pretty benign. What's more, companies like Sanofi and Biogen Idec (BIIB) continue to loom as highly significant competitor.
On the flip side, there's still a reasonable chance that Teva will win its Copaxone patent litigation and the results from the GALA study could create some new dosing options.
Keep On Keeping On
As long as investors stay realistic and rational about Teva's future, I don't quite understand all of the pessimism that goes with this stock. Yes, the generics business isn't going to be what it has been, what with the number of high-value upcoming drug patent expirations shrinking. At the same time, though, biosimilars could well add some meaningful revenue, and I see no reason why Teva won't be competitive with Watson (WPI) and Mylan (MYL) here.
What's more, the company does have extensive manufacturing and distribution scale. Run some additional branded products through this system (whether acquired or in-licensed) and the incremental profits could be pretty solid, to say nothing of the possibilities of the over-the-counter partnership with Procter & Gamble (PG).
The Bottom Line
On the assumption of roughly 7% compound free cash flow growth over the next decade, a 10% discount rate, and adjusting for the balance sheet, I believe Teva's fair value is somewhere in the mid-$50s today.
If it weren't for the fact that names like Pfizer, Merck (MRK), and Sanofi look so cheap to me today, I'd probably be a lot more enthusiastic about recommending Teva. As it stands, though, Teva is underpriced and has a lot more growth options in front of it than those giant Big Pharmas (simply by virtue of being smaller, that is).