Value investors are familiar with pain. They endure pain when the stock hits a low, then falls some more. The markets are hammering Teva Pharmaceutical Industries Ltd (ADR) (NYSE:TEVA) because it’s constantly reporting bad news. The CEO is leaving, Copaxone’s patents were invalidated by the U.S. courts, and generic drug manufacturers are out of favor. These and other headlines have driven TEVA down by about 45% over the past year.
But Teva’s slump might finally be ending … and soon.
Teva Trades at Ridiculously Low Valuations
Thanks to those losses, TEVA stock trades at a forward price-to-earnings ratio of less than 7. Although earnings are decelerating this fiscal year, the underperformance is due mainly to its massive $40.5 billion acquisition last year.
The company completed its acquisition of Actavis Generics on Aug. 2, 2016. TEVA bought the unit from Allergan plc (NYSE:AGN). At the time, Teva said its global scale and R&D platforms would improve. Teva would gain exposure to 80 markets and would have a top-three leadership position in more than 40 markets.
The hope was that Actavis would help make up for a decline in its vital Copaxone business, but the market doesn’t see that happening.
Copaxone is a significant slice of the Teva pie:
If we look at our profit split, the generics business represents approximately 50% of our business while Copaxone represents approximately 35% and other specialty products represent the remaining 15%.”
In its 2017 financial outlook, Teva forecast sales of between $3.8 billion to $4 billion for Copaxone. The company will still generate solid positive cash flow of $2 billion; any cut to the $1.5 billion in cash flow for the drug itself will not happen quickly. In its 2017 financial outlook, Teva did not anticipate generic competition for Copaxone 40 mg/mL in the U.S.. It will take a few quarters before competitors like Mylan NV (NASDAQ:MYL) or Pfizer Inc. (NYSE:PFE) can sell generic versions of Copaxone.
Still, the company did forecast overall revenues dropping by $1 billion to $1.2 billion, due to two generic competitors entering the U.S. market.
And despite the latest patent ruling against Teva, in which a district court invalidated four claims of patent infringement, Teva did not lower its outlook further.
Actavis Generics will contribute to $2.1 billion in EBITDA, but markets fear management may cut forecasts for the unit. If Teva wants to rely less on Copaxone and more on Actavis, it must cut costs and boost operating efficiency at Actavis to make up for the difference. After all, Teva took on quite a bit of debt to make the monstrous purchase.
Teva reported on Feb. 6 that CEO Erez Vigodman is stepping down, providing yet another avenue of uncertainty for TEVA stock holders. Vigodman owned up to the company’s underperformance, but the departure comes at an unfortunate time — ahead of the company’s quarterly earnings report on Monday, Feb. 13.
Dr. Yitzhak Peterburg — a current chairman who was VP of Global Branded Products from October 2010 through October 2011 — has been tapped as interim CEO.
Now, the focus is on hiring a CEO that can stabilize Teva’s businesses and generate enough cash flow to pay off the roughly $26 billion in extra debt that the company took to buy Actavis.
TEVA Stock Isn’t in the Clear
Investors should not rule out another drop when the company reports its fourth-quarter results on Monday. The delay in closing the Actavis Generics buyout also prevented Teva from cutting costs earlier. TEVA might meet analyst expectations for the quarter, but very likely could issue a week outlook for the quarter and the year.
In short, Teva has a long way to go before earning back investor trust.
The flip side? As Teva optimizes its generics business, it should be able to exploit its strengths. That means more volume, followed by more R&D spend, which will restart the virtuous cycle of outdoing its competitors.
The good news for any TEVA stock bulls is that the more it drops, the more of a discount investors can buy into. But it’s still a very dangerous game.
As of this writing, Chris Lau did not hold a position in any of the aforementioned securities.