Teva Pharmaceutical Industries Ltd (ADR) (NYSE:TEVA) desperately needed some good news heading into its fourth quarter earnings report. TEVA stock hit its lowest level in over a decade the week before, after its CEO resigned abruptly.
The departure of CEO Erez Vigodman came amidst reports of bribery investigations in the company’s home country of Israel. And it came after a long decline in TEVA stock, driven by pricing pressure, questionable acquisitions, and a “patent cliff” for Teva Pharmaceutical’s key drug, Copaxone.
And while Q4 earnings delivered, the news wasn’t great. Revenue increased 33%, but that came almost solely from the acquisition of Allergan plc’s (NYSE:AGN) generics business. Teva Pharmaceutical paid $40.5 billion in a transaction that has boosted sales as well as Teva’s debt load. Margins were pressured, reflected in non-GAAP EPS that increased just 8% despite the 33% rise in sales.
But the company also reaffirmed 2017 non-GAAP EPS guidance of $4.90-$5.30. That eased fears of another reduction in the 2017 outlook, which had been cut in January from $6-$6.50. The news was enough to drive a “relief rally” in TEVA stock, which now has climbed more than 10% from its lows.
There should be more upside ahead, even if the road might be bumpy. Teva does have numerous risks, both near-term and long-term. But it also has tremendous potential, a cheap multiple, and a new CEO on the way. There’s a turnaround opportunity in TEVA stock and it doesn’t look quite priced in.
Why It’s Crazy to Buy Teva Stock
Admittedly, there are concerns across the board for Teva stock. The patent invalidation for Copaxone, a multiple sclerosis treatment, puts an estimated 20% of revenue, and possibly 40%-plus of profit, at risk. On the Q4 call, CFO Eyal Desheh estimated an $800 million cash flow impact in 2017, should competition enter immediately.
That entrance — which would occur if Teva loses its appeal — also would shave 75 to 95 cents off EPS.
The combination of lower earnings and higher debt after the Allergan deal raises another risk. Teva’s leverage ratio (net debt to EBITDA) at the end of 2016 was 4.7. That doesn’t imply immediate risk of bankruptcy, to be sure. But Teva bonds that mature in 2026 have fallen about 12% just since September. Clearly, the debt markets are pricing in a greater, if still modest, possibility of a restructuring that could wipe out TEVA stock.
The company now faces the challenge of finding a new CEO. Both previous CEOs left relatively quickly, amid questions of fit within Teva’s culture and clashes with the company’s board. The company’s current bylaws require the CEO to reside in Israel, though it’s possible those could be changed for the next candidate.
The bear case for TEVA stock is that, yes, it is cheap — and for good reason. Declining profits, a $36 billion debt load, concerns about generic pricing, and the loss of Copaxone all present significant risks. And those risks justify a 7x multiple to the midpoint of 2017 EPS guidance.
Why Teva Stock Is a Buy Nonetheless
Those concerns are valid. But they’re also backward-looking.
Teva has numerous options to improve its situation, and interim CEO Yitzhak Peterburg said on the Q4 call that Teva would “leave no stone unturned” in considering those options.
And what’s important to keep in mind is that the situation isn’t all that dire. Yes, bonds have fallen; but the yield to maturity still is just 4.4%, implying a very low chance of bankruptcy over the next decade. The leverage ratio could move above 5x if Copaxone competition moves in; but that remains a manageable level. This isn’t Valeant Pharmaceuticals Intl Inc (NYSE:VRX); Teva’s back isn’t against the wall.
The company has options. TEVA is targeting a 3.5x leverage ratio, and likely will consider asset sales as a path to those levels. There’s still the possibility of a split between the branded and generic businesses, something Wall Street has long targeted. (That decision appears up to the new CEO, per the Q4 call.)
Copaxone sales and profits aren’t going to zero, even if generic competition enters immediately. And the same goes for Teva Pharmaceutical earnings. This remains the largest generic drug manufacturer in the world based on revenue. With rising health care costs a concern pretty much everywhere, and drug pricing a key part of those concerns, that’s a major long-term competitive advantage for Teva.
And TEVA stock is cheap – even assuming the worst about Copaxone. Using the low end of 2017 guidance and the high end of the guided Copaxone impact still puts 2017 EPS near $4, and TEVA stock’s P/E multiple below 10. Simply stabilizing the business at those levels likely implies a 12-13 multiple — and gets TEVA stock to $50.
It’s always difficult to time the bottom in any stock. But the Q4 earnings from Teva Pharmaceutical seem to imply that the company at least has a handle on its challenges. Looking forward, the debt load isn’t so big that the company is forced to do anything, and a new CEO will bring fresh eyes.
There are concerns, to be sure. But Teva Pharmaceutical has a lot of tools still at its disposal to answer those concerns, and push TEVA stock higher.
The author has no position in any securities mentioned.