It seems trouble in the pharma world knows no end. First it was Valeant Pharmaceuticals Intl Inc (NYSE:VRX). Now it’s Teva Pharmaceutical Industries Ltd (ADR) (NYSE:TEVA). VRX stock crashed from a high above $260 in mid-2015 to $14 today. TEVA stock appears to be on a similar downward spiral, falling from a $70 high in mid-2015 to $18 today.
So what’s happening under the hood here?
Well, these pharma companies got overly ambitious. Both TEVA and VRX figured that a good game plan in a low-interest-rate, easy-credit environment would be to use a debt-financed acquisition strategy to drive robust top-line growth.
The game plan was pretty straightforward. Take out a bunch of debt. Acquire a bunch of pharma companies. Reap the top-line rewards that accompany market share expansion. Gradually pay off debt. The net result would be much larger top- and bottom-line numbers with a manageable debt load, and consequently, much higher stock prices.
But things didn’t go as planned for either company. Pricing and accounting scandals entered the fold. The U.S. Food and Drug Administration began to speed up the rate at which they approved drugs, and that caused a rush of new, competitively priced drugs into the market. Pharmacy chains began to consolidate their orders, giving them leverage in price negotiations.
All in all, things didn’t go perfectly for either VRX or TEVA. When you have a bunch of debt on the balance sheet and operations don’t run smoothly, investors freak out.
Most of the market has thrown in the towel on Valeant. It feels like yesterday’s news. Even its biggest bull, famed hedge fund manager Bill Ackman, recently exited his position after a $3 billion loss on his $4 billion investment.
But the TEVA debate is just heating up. And that’s because it just announced dismal quarterly results which underscored the company’s problems: too much debt and too little growth.
TEVA stock is down more than 40% since that report on Aug. 3.
But is the sell-off an overreaction? Maybe.
Here’s why.
TEVA Has Higher Turnaround Potential Than VRX
Much like VRX, there is no doubt that TEVA stock is drowning in debt. Teva has about $35.1 billion in total debt on its balance sheet. That compares to a market cap of roughly $18 billion.
It’s not great to see a company have almost twice as much debt as its market capitalization. But in a case when the stock has been beaten up so badly and is drawing comparisons to VRX, it is great to see that “too much debt” is where the problems end.
With TEVA, there are no accounting scandals. There is no secret relationship with a sketchy specialty pharmacy company (remember the Valeant-Philidor relationship?).
In fact, operations at TEVA will likely go on without much of a hiccup, albeit with stiffer competition and tighter margins.
The generics drug market isn’t as dead as many think it is. Perrigo Company Plc Ordinary Shares (NYSE:PRGO) stock surged more than 15% higher last week after the company reported robust revenue and earnings growth in Q2. This signals that the sky is not falling in the generics market.
Bottom Line on TEVA Stock
PRGO’s second-quarter results give me confidence in TEVA management’s fiscal 2017 guide. That guide calls for earnings per share of around $4.40. At $17.50, TEVA stock is trading around 4 times this year’s earnings per share guide.
That seems just too cheap to ignore, especially considering revenues are up double digits this year. As margins stabilize next year, strong revenue growth will spill into strong earnings growth. That means investors at these levels are paying 4 times earnings for earnings that will likely grow in excess of 10% per year over the next several years.
Granted, the dividend cut is huge and makes this stock no longer a safe place to hangout for dividend investors. The debt still looms large. The VRX comparisons are still there.
But all that feels largely priced in here. This is not a stock for the faint of heart, but I think it’s worth a shot considering the depressed valuation and the growth profile.
As of this writing, Luke Lango was long TEVA stock.
