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Why Teva Pharmaceutical Industries Ltd (ADR) (TEVA) Stock Is Risky

TEVA stock is down over the past 18 months; is Teva undervalued or correctly priced?

By Lucas Hahn, InvestorPlace Contributor


Teva Pharmaceutical Industries Ltd (ADR) (NYSE:TEVA) stock is down 40% over the past year, and down more than 50% since August 2015. Admittedly, the past year and a half hasn’t been great for pharma stocks in general; the VanEck Vectors Pharmaceutical ETF (NASDAQ:PPH) is down 25% since then as well. This was about the same time that Valeant Pharmaceuticals Intl Inc (NYSE:VRX) stock peaked as well.

Why Teva Pharmaceutical Industries Ltd (ADR) (TEVA) Stock Is Risky

TEVA stock has had additional problems, facing slow growth in its generic business, the sudden departure of one executive and the ousting of the CEO, and mounting debt.

But Teva Pharmaceuticals’s valuation looks cheap: TEVA stock trades at 6.7 times forward earnings, 11 times free cash flow, 1.10 times book value and boasts a 4.2% dividend yield.

Some see this as a buying opportunity; indeed, David Tepper of Appaloosa Management increased his position in Teva Pharmaceuticals during the fourth quarter.

Does TEVA stock face substantial risks? Or is the market overreacting and mis-pricing Teva Pharmaceuticals?

I would argue that TEVA stock isn’t undervalued, since the company faces substantial risks going forward. Let’s look at these in detail.

Unfavorable Political Climate for TEVA and Other Pharma Stocks

The rising tide of populism won’t be good for pharma stocks; politicians are very much focused on bringing drug prices down. Voters are angry, and could care less about the impact their anger has on the capital markets, including biotech and pharma stocks.

As I mentioned, the pharmaceutical industry hasn’t done well in the last 18 months, and other firms like Valeant have suffered. Why? In September 2015, the controversial fund manager Martin Shkreli, whose Turing Pharmaceuticals bought the anti-parasitic drug Daraprim from Impax Laboratories Inc (NASDAQ:IPXL), increased the price of Daraprim 5,500%.

This, occurring just as the Americans prepared for the 2016 presidential election, set off a political firestorm and candidates rushed to condemn Shkreli and the pharmaceutical industry in general. Valeant got a lot of heat for this as well, as I wrote about last week. The Senate also investigated Teva Pharmaceuticals’ competitor, Mylan N.V. (NASDAQ:MYL), over its 600% increase in the price of the allergy shot EpiPen.

TEVA bought Actavis, the generic division of drugmaker Allergan plc Ordinary Shares (NYSE:AGN), in response to falling generic drug prices. Analysts hoped that this would give Teva Pharmaceuticals greater bargaining power with customers and allow it to raise prices, or at least keep them from falling. But this merger took place before the Martin Shkreli/Daraprim controversy, which brought public scrutiny to the pricing practices of pharmaceuticals.

Last year, the Bloomberg Gadfly columnist Max Nisen wrote an article questioning the benefits of the TEVA/Actavis merger.

The industry faces a criminal price-fixing investigation. Teva Pharmaceuticals received a subpoena for this in December and is cooperating. Twenty states also filed a civil suit against drugmakers, including TEVA and Mylan, over price fixing. The company also had to pay $519 million to settle a Foreign Corrupt Practices Act suit in December, and faces a related criminal probe in its home country Israel.

Teva Pharmaceuticals’ Copaxone Woes

Ironically, given that TEVA stock is mainly known for producing generic drugs, 35% of its profit comes from Copaxone, a drug used to treat multiple sclerosis, which it holds the patent to. However, in September and January, the U.S. government struck down the company’s patent claims.

Novartis AG (ADR) (NYSE:NVS) and Momenta Pharmaceuticals, Inc. (NASDAQ:MNTA) already launched a generic version of Copaxone, Glatopa, in 2015. TEVA responded by releasing a 40mg version that only needed to be administered three times a week, but lost its patent claims last year. Now, this version could face generic competition as well. Teva Pharmaceuticals could lose $1.1 billion to $1.2 billion in revenue and $0.65 to $0.80 per share in profit this year.

Admittedly, concern over Copaxone is not new to TEVA stock; this was already an issue when former CEO Erez Vigodman took charge in 2014. But the company faces this in addition to trouble with generic drug prices.

TEVA Stock: Leadership Transitions

Teva’s CEO, Erez Vigodman, resigned in February. Yitzhak Peterburg assumed the position of caretaker CEO, while the company searches for a permanent one.

This followed the sudden departure of Sigurdur Olafsson, head of Teva Pharmaceuticals’ global generics business, in December 2016. Olafsson played a major role in the acquisition of Actavis, and his exit surprised and unnerved TEVA stock shareholders.

Gilad Alper of Excellence Nessuah, an Israeli investment bank, commented: “This has raised a red flag with investors as there are concerns that something is going wrong with the acquisition … that is a scary thought.”

And Teva’s previous CEO, Jeremy Levin, had been ousted in October 2013 over differences with the board, a move Moody’s called “credit negative” at the time.

It looks like TEVA stock can’t find a strategy that works; Levin and Vigodman followed different approaches. As mentioned in the Times of Israel,

“Levin had spearheaded cost-cutting measures and was pushing the company to develop and acquire more branded drugs. Vigodman felt the right move was to lead Teva back to basics, its generics business. And, while increasing efficiency at the company, he also set out on a shopping spree.”

TEVA Stock’s Financials

Teva Pharamceuticals responded to pricing weakness on generic drugs and the threat of Copaxone copycats by launching a wave of mergers and acquisitions, spending $40.5 billion on Actavis. Before this, TEVA stock’s debt levels looked better than its peers. Now, Teva with net debt 5.43 times EBITDA, ranks among the most indebted drugmakers.

This heavy debt load may make it difficult for Teva Pharamceuticals to maintain its high dividend, currently yielding 4.2%. The company faces a heavy debt load, but its ability to pay back debt may be decreasing, with pricing pressures on generic drugs and competitors introducing generic versions of Copaxone.  

TEVA’s financial position appears to be eroding over time.

The company’s Altman Z-score fell from 2.48 in 2015 to 0.84 in 2016. Scores over 2.9 are considered “safe”, while scores under 1.23 are not, and 1.23 to 2.9 is a gray area. TEVA stock ventured into unsafe territory last year.

Its debt-to-equity ratio tripled, going from 0.33 in 2015 to 1.07 in 2016.

In 2015, TEVA’s operating cash flow to total debt ratio stood at 0.56, but this fell to 0.15 in 2016.

Teva Pharamceuticals’  interest coverage ratio fell from 19.06 in 2015 to 10.39 in 2016.

As of writing, Lucas Hahn did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, https://investorplace.com/2017/04/teva-pharmaceutical-industries-ltd-adr-teva-stock-risky/.

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