Teva Pharmaceuticals (TEVA): The Best Long-Term Play in Pharma

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If you’ve been following the pharma business lately, you’ve probably noticed that there’s an M&A smorgasbord going on.

We’ve all heard the rumors that Pfizer had tried to buy GlaxoSmithKline (GSK). Before then, Pfizer had tried (and failed) to takeover AstraZeneca (AZN). Later, Teva Pharmaceuticals (TEVA) bought the generic unit of Allergan (AGN) for $40 billion, but that wasn’t long after it had first explored Mylan (MYL).

Teva Pharmaceuticals (TEVA): The Best Long-Term Play in PharmaWhat is going on? Why the big run towards consolidation and mergers? Well, two reasons spring quickly to mind.

First, it’s cost reduction, either by improved operational efficiency or by tax efficiency. But while cost reduction is all well and good, that’s not the reason. The second reason — the big reason — is to gain larger market share.

Which leads us to the question: A larger market share of what?

Developers vs Generics

Pfizer, Merck and Teva are all in the pharmaceuticals business, but they’re not necessarily within the same revenue stream.

PFE and MRK focus more on developing new drugs for cancer, Alzheimer’s and countless other diseases. Thus, their M&A strategy is to buy smaller research companies that could help them achieve better results in their own drug research. This business model requires a lot of research investment. On the other hand, it also means the drugs they sell tend to be more expensive … at least until their patents expire.

Teva, however, is more oriented toward generic drugs. Those are drugs initially developed by the likes of Pfizer and Merck, but whose patents are expiring/have expired. Once off-patent, other companies can sell generic versions of the drug for much lower prices (and often at a much larger scale).

And this is really what Teva’s business is all about: scale. That’s exactly why TEVA bought Allergan’s generic unit — it wants to make sure it continues on as the world’s biggest generic drugmaker.

TEVA Stock has a Superior Model 

If we can decide which segment is better to be in (development vs generic), then theoretically, it should be easier to decide whether you should own TEVA stock, or a more traditional pharma company like PFE or MRK.

Naturally, that answer is far from clear.

While developing new drugs might have better margins because of the higher initial price, the patent protection aspect complicates matters. R&D investment — whether it’s via direct development or acquiring smaller companies — is onerous, and it can take a long time for research costs to pay off in tangible revenues.

Plus, unlike the big mergers in the generic sector, traditional pharma buyouts tend to have more uncertain, mixed results.

Let’s not forget that when a drug patent expires, generic drug makers enter the competition. Generic drug manufacturers like TEVA, can just swoop in on an already “sure thing” and repackage it as needed. That means that a developer’s profitability in the long run is uncertain, too.

In the generic drug business, margins are lower and competition is more cutthroat, but it’s also a more stable business, as economies of scale make it easier to ink deals with insurance companies and big distributors. So at least in generic drugs, the rewards are more predictable.

TEVA Stock: Beyond the Numbers

Teva, Pfizer and Merck all managed to beat the Street in their most recent earnings reports, which is nice, but only really gives us a snapshot. Looking more broadly, TEVA stock and PFE stock are very close when it comes to fundamental ratios, as well as their business performance.

However, in an age when aggressive M&A dominates the sector and uncertainly over long-term profits looms, you want to position yourself in the more sustainable business — and that’s the generics realm in which Teva Pharmaceuticals resides.

TEVA stock trades at a scant 13 times earnings, and it’s the leader in a big, steady market. To me, that makes Teva Pharmaceuticals the best way to play the pharma space.

As of this writing, Lior Alkalay did not hold a position in any of the aforementioned securities.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/08/teva-stock-best-long-term-play-pharma/.

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