Teva CEO Kare Schultz
Teva (NYSE:TEVA) delivered a Q1 2018 revenue and earnings beat. I was actually surprised the company's revenue of $5.1 billion was only off 10% Y/Y. I was expecting a much bigger decline. Below is my takeaway on the quarter:
Copaxone Revenue Not Free-Falling As Predicted
Teva is a tale of two different continents. Revenue from North America was off by about 22% Y/Y, while Europe and Growth Markets were up by single-digits.
North America represents over 50% of total revenue. Revenue from Generic products has been hard-hit in the region; revenue from North America Generic products fell 23% as large institutions continue to negotiate volume discounts and the FDA brings new drugs to market faster than in previous years. Generic Copaxone has mostly impacted Copaxone sales in North America - another headwind for the region. Meanwhile, Europe revenue was solid due to new drug launches. Revenue growth from Europe and Growth markets helped offset the diminution in North America.
The biggest win for Teva during the quarter was that Copaxone sales did not free-fall. Copaxone sales in North America were down 40%, while sales in the rest of the world were relatively stable. Mylan (MYL) launched generic Copaxone in the second half of 2017. I estimated total Copaxone sales could eventually fall by around 70%. Copaxone sales have actually been stickier than expected. First of all, on Teva's Q3 2017 earnings call management intimated it had negotiated contracts for Copaxone in advance of generic Copaxone's arrival:
Of course, we've been waiting and ready for a generic to launch. But when Mylan came – and we've really had a very good position with most of the payers and PBMs, securing just over 60% of our units through contracts. And we've really been executing on that extremely fast.
I interpreted this to mean that a certain amount of Copaxone's business would not be up for bid even after Mylan's launch. This likely explains why the decline in Copaxone's Q1 2018 North America revenue was driven mainly by a loss in price instead of market share. Per Teva's management presentation, Copaxone controlled 85% of 40mg TRx market share for the week ending March 30, 2018; Mylan's generic version controlled about 15%.
Market chatter previously suggested Mylan’s European partner, Synthon, and Alvogen had received European approval for a 40-milligram dose of glatiramer acetate, as Copaxone is known generically. Once launched, a generic version could cut into Copaxone sales in Europe; Europe currently represents over 20% of total Copaxone sales. Going forward, management expects generic competition to further weigh on Copaxone, resulting in higher price reductions and lower volumes. Since Copaxone had an 80% segment profit margin, I expect future hits to the drug to weigh heavily on Teva's EBITDA and cash flow.
Teva Is Cutting Costs To The Bone
Teva's Q1 gross margin was 46%, down from 50% in the year-earlier period. Declining sales and declining gross margin caused gross profit to decline by 17% Y/Y, outstripping the 10% sales decline. The company made up for the loss by cutting operating expenses to the bone. Total R&D and SG&A costs were $1.4 billion, down 19% Y/Y. As a result, Teva was able to maintain an EBITDA of 28% which was practically flat versus that of Q1 2017.
Management plans to reduce operating costs by $3 billion due to restructuring efforts; about $1.5 billion of those reductions are expected this year. Teva was able to cut operating expenses and cost of goods sold by over $400 million in Q1. That puts it on track to wring out $1.5 billion of expenses this year. The question remains, "Will the company create inefficiencies from such large cost takeouts?" Cuts to R&D could hurt future drug launches. Secondly, reductions in sales and marketing could put the company's products at a disadvantage vis-a-vis competing drugs that have larger marketing and advertising budgets.
Credit Metrics Still Intact For Now
At Q4 2017 Teva's debt/run-rate EBITDA was 5.4x. Several rating agencies downgraded its debt to junk status. I was certain its credit metrics would deteriorate further. The company cut its debt load by $1.7 billion during the quarter; that and cost takeouts allowed it to lower debt/run-rate EBITDA to 5.1x. I believe cost takeouts have come well in advance of Copaxone declines. Once price and volume for Copaxone decline in North America and a generic version is finally launched in Europe, the company's EBITDA could tumble. Deteriorating credit metrics could lead to additional debt downgrades, hurting sentiment for the stock.
Conclusion
Teva delivered a solid Q1, but things will likely get worse for Copaxone sales, cash flow and the stock. Sell TEVA.
