Seeking Alpha
Profile| Send Message| ()  

We recommend investors take a long position on Teva Pharmaceutical Industries (TEVA) based upon the following key points:

  • The stock is currently undervalued and is trading at forward P/E of 6.8x, as compared to the industry average of 11x. Its low PEG ratio of 0.95, as compared to Pfizer's (PFE) 4.98, Merck & Co.'s (MRK) 2.68, Watson Pharmaceuticals' (WPI) 1.16 and Johnson & Johnson's (JNJ) 2.18 makes it attractive.
  • The company's revenues from branded products increased by 6% over the last quarter, reflecting Teva's advantage when it comes to the production of specific medicines.
  • There are several of the company's products either awaiting FDA approval or in their third clinical trial phase. The company's R&D spending increased by 22% over the last one year, which will help Teva in the development of a strong drug portfolio.
  • The company's dividend yield is 2.5%, greater than its free cash flow yield of 7.73%, showing that Teva has the ability to pay off its dividends without any debt support.
  • The latest drug being developed by the company, which is similar to Amgen's (AMGN) Neupogen, will help Teva capture its competitors' market share.

Teva is well known for its drugs Azilect and Copaxone. It is manufacturing drugs for all treatment categories. This global pharmaceutical manufacturer, through vertical integration, builds its own raw materials that are required in drug manufacturing. For vertical integration, the company has established an API (active pharmaceutical ingredients) business. Teva's branded products are segmented into five different categories, namely central nervous system, women's health, respiratory, oncology and pain. Moreover, the company is a global leader with more than a 20% market share in the generic category of pharmaceuticals. The company manufactured approximately 71 billion tablets last year, and each day, one of its products is mentioned in 1.5 million prescriptions in the United States. The company's sales mix by geographic regions comprises 49% from the United States, 30% from Europe, and the remaining 21% from the rest of the world.

Due to European macroeconomic headwinds, the company has witnessed a decrease in its generic business in the continent. Moreover, Teva's success in winning a patent case against its high valued branded product Copaxone will enable the stock to show an upward movement in the coming years. Teva receives the highest revenue contribution (20%) from Copaxone. The high courts of England and Wales have declared that Copaxone patents will be valid till May 2015.

We can expect some other products to be launched in the near future, as some of the company's products like Omacetaxine, Beclomethasone dipropionate HFA Nasal, Progesterone Vaginal Ring and ProAir™ HFA Dose Counter are in their FDA submission phase. Teva's medicine NexoBrid, used to remove burn tissues, has been submitted to the EMA. Moreover, other products like Glatiramer acetate 0.5ml, Glatiramer acetate 40mg, Laquinimod, Reslizumab, Tamper deterrent hydrocodone, and R-Modafinil are in their third round of clinical trials.

The patents for Azilect, one of the company's most renowned drugs, are valid until 2017. The other two important company products in the central nervous system category, NUVIGIL and PROVIGIL, have exclusive patents until 2015. The company generated 2% and 1% in revenues from NUVIGIL and PROVIGIL, respectively, in the last quarter. The exclusivity of another important branded product, pro Air, has been secured with 5 patents, with the last one expiring in 2028.

Financial Analysis

Direct Competitor Comparison

Teva Pharmaceutical

Pfizer Inc

Merck & Co

Watson Pharmaceuticals

Johnson & Johnson

Market Cap:

34.29B

178.67B

132.30B

10.60B

185.47B

Qtrly Rev Growth (yoy):

19%

-9%

1%

25%

-1%

Gross Margin (TTM):

54%

79%

66%

43%

68%

Operating Margin :

24%

30%

23%

14%

25%

The company's operating margins of 24% are low as compared to Pfizer's 30% and Johnson & Johnson's 25%. The lower operating margins are credited to a 22% increase in marketing and selling expenditures in the last one year. The company's revenues have considerably increased by 19% YoY. Its proportion of sales from Europe has declined from 35% to 30% in the last one year due to the economic turmoil in Europe that we have already talked about. Teva's net income and EPS registered an increase of 50% and 55% over the last one year. Furthermore, it has posted cash flow from operations of $1.2 billion and free cash flows of $709 million in the second quarter.

Teva's 50-days' and 200-days' moving averages are $40.3 and $42. The stock is trading at 5% above its last three-month price. The beta of 0.26 implies the low volatility of the stock with respect to the S&P 500. The stock has significant potential to move upwards, as it is already trading at low multiples.

Direct Competitor Comparison

Teva Pharmaceutical

Pfizer Inc

Merck & Co

Watson Pharmaceuticals

Johnson & Johnson

TEVA

PFE

MRK

WPI

JNJ

PEG (5 yr expected):

0.95

4.98

2.68

1.16

2.18

P/S :

1.7x

2.75x

2.74x

1.93x

2.86x

Forward P/E (2013)

7x

10.35x

11.68x

10.21x

12.32x

Dividend Yield

2.50%

3.59%

3.70%

NA

3.50%

Estimated Earnings growth rate (2013)

9.4%

5%

-2%

41%

8%

We have calculated our 2013 target price of $77 using an EV/EBITDA multiple, with an upside of 92%. The stock is trading at 7x to its forward earnings, which is at a significant discount when compared to the figures for PFE, MRK, WPI and JNJ, which are 10.3x, 11.6x,12.2x and 12.3x, respectively. According to analyst estimates, its EPS will grow by 8% by the end of 2013, which is at par when compared to JNJ and relatively high in comparison to Pfizer and Merck & Co.

Its free cash flow yield of 7.8% is higher than its dividend yield of 2.5%. The company's dividend payout ratio has increased from 20% to 30% from 2010 to 2011, as reflected in the above chart. The company's dividends grew with a CAGR of 20.2% in the last five years. The management has declared second quarter dividends of 25 cents. Moreover, Teva has repurchased 3.5 million shares for $134 million in the last quarter, which will enhance the returns of its shareholders.

Following are the details of Teva's valuations and target price of $77.

Average. EV/EBITDA (Last five years)

11.2

Estimated EBITDA of 2013 ($ millions)

$6,967

EV

$ 78,030

EV

$ 78,030

Less: (Debt) ($ millions)

$12,625

Add: Cash ($ millions)

$1,188

Equity ($ millions)

$ 66,593

No. of shares (millions)

867

Target Price of 2013

$77

Conclusion

The stock is undervalued and has considerable prospects to show an upward trend with the launch of new products, which are currently awaiting FDA approval. Copaxone's patent validity until 2015 will enable the company to sustain its revenue growth. The recent FDA approval of its medicine, which is similar to AMGN's Neupogen, is a positive sign for the company's future growth. The medicine will enable white blood cells to resist blood infections in cancer patients. Neupogen's patents will expire next year; therefore, we believe the company has made this move at the right time. According to a survey by IMS Health, sales of biosimilars will increase up to $2.6 billion by 2015 (current sales are $1.9 billion). The industry has all the reasons to grow in order to cope with the increasing demand, and Teva has immense potential to capture this growth through its dynamic laboratories and patent protections. According to the estimates of 27 analysts, its earnings will grow by 9.4% by the end of fiscal year 2013; not a single analyst has given a sell recommendation for Teva.

Source: Why Analysts Love Teva