Even though generic drug supplier Teva Pharmaceutical Industries Limited (NYSE:TEVA) is nearly double from its bottom set last November, chances are good that Teva stock will continue moving up. The U.S. government is shifting its focus from accusing drug companies of overcharging to encouraging the marketplace to operate more competitively.
On May 31, FDA Commissioner Scott Gottlieb, announced a draft guidance that will limit drug companies in delaying generics to market. Generic firms will soon have the option of applying for a waiver of a Single Shared System REMS, or Risk Evaluation and Mitigation, requirement. The proposal is highly reasonable. Previously, generics needed to negotiate with branded firms.
Teva Pharmaceuticals stands to benefit significantly with the fairer rules. The company spent $40.5 billion to buy Actavis from Allergan plc (NYSE:AGN). While it may have overpaid, markets grew uneasy over its debt/equity ratio. But since May, TEVA stock rocketed from $18 to trade recently at $23.
The rally matches that of Valeant Pharmaceuticals International (NYSE:VRX) rising 27 percent in the last month and Endo International plc (NASDAQ:ENDP) jumping 31.5 percent.
Macro Fundamentals Improving for Teva Stock
The generic drug landscape will grow and become more profitable for all players despite a downward pressure on pricing. The higher competition will encourage branded and generic suppliers to spend more on R&D. By investing in the product, consumers ultimately benefit and as the products get better, demand will only go up.
Teva’s product mix is well-balanced at the moment. It has new product launches that will replace generics that are at the end of their lifecycle. Teva’s blockbuster Copaxone, which faces generic competition, held the 85 percent market share in the first quarter for the 40 milligram dosage.
The steady sales allowed Teva to cut its debt to below $30 billion in the quarter. Lower Copaxone sales in the first quarter hurt gross margin. The company offset the negative price impact from generic competition through its restructuring program.
Now, the cost-cutting efforts will weigh on short-term results but ultimately help the company’s longer-term profits. So, as long as cost reductions outpace the 10 percent revenue loss in future quarters, Teva will be better off. Looking ahead, Teva forecast cash flow increasing from the previous $2.6 billion to $2.8 billion range to $3.0 billion to $3.2 billion.
The government’s proposal on encouraging competition for generics reduces the unknowns in the pharmaceutical marketplace. With the unknowns dissipating, Teva may confidently forecast generic drug sales in the U.S. and globally. Yet Teva is getting ahead of the curve as lower drug pricing requirements threaten the industry.
The company optimized its portfolio with the primary purpose of maximizing profits. It solidified collaboration with its key customers to ensure the steady supplies match patient demand levels. For 2018, Teva expects it will make $4 billion in revenue.
Patients Win from More Competition
Patients clearly benefit when drug prices take it hit. As long as Teva holds its market share, the company stead to benefit from the new environment. Still, Teva stock has some headwinds ahead. Generics hurt sales of Copaxone 40 milligram.
In the first quarter, the company cut enough of its costs to minimize the negative impact of lower Copaxone sales. Its dramatic increase in FCF, from $0.3 billion to $1.9 billion year-on-year proves that the business’s overall health is getting better.
Valuation and Takeaway for Teva Stock
The average price target on TEVA stock is around $20, below its recent close of $23.19 on June 11. Although the company earned three “buy” calls in the last month, the latest coverage on Teva called for selling the stock. The price target from Leerink Partners is just $16:
SimplyWall.St figured the fair value, based on future cash flow, is nearly $41 a share.
The opinions on Teva vary by a wide margin and after a long decline, the company’s pricing challenges ahead are clear enough for investors. After cost cuts are completed and the company rolls out new products, the stock will respond favorably.
Chris Lau has no position in any of the aforementioned companies.