The last few years for drug-maker Teva Pharmaceuticals (NASDAQ:TEVA) haven’t exactly been that wonderful. TEVA stock has plunged on a series of mishaps and issues. In fact, TEVA has fallen enough that America’s favorite value investor, Warren Buffett, has taken a huge interest in the stock over the last few quarters. And the interest is growing as the Oracle of Omaha continues to up that stake.
But with a new government probe and the hints of a massive cartel related to generic drug prices, the question is whether or not Buffett and his disciples are making a huge mistake. Could TEVA not be the value people think it is? Is there more pain ahead for the maker of generic drugs?
Or could the latest leg down be a huge opportunity for more buying?
A Rocky Year For TEVA Stock
The problems for Teva started over a year ago and like many firms, the issue is Debt — with a capital “D.” In a bid to become the world’s largest generic drugs maker, Teva took on roughly $40.5 billion in debt to buy Allergan’s (NASDAQ:AGN) generic-drug business. The move was done to help limit losses on declining sales for Teva’s top-selling drugs like Copaxone. On the surface, the buyout seemed great. But like many M&A actions, it was made at the near top of the market for generic drugs. The irony is that Copaxone fell victim to generic competition from Mylan (NYSE:MYL) itself.
As a result, pricing on generics plunged and cash flows at TEVA dried up.
The drugmaker was forced to slash its dividend by 75% and then cut it entirely to help pay back that debt load. Teva launched a huge initiative to cut costs, turn itself around and boost profitability and cash flows. During this time, the dip in the stock proved too juicy for Warren Buffett and through Berkshire Hathaway (NYSE:BRK.A), the value investor took a huge stake in the stock.
And he kept on buying. As the end of the second quarter, Berkshire now owns roughly 43.2 million shares of TEVA stock — an increase of 4.3% over what it held during the first three months of the year. The good news for Buffett and investors is that TEVA’s turnaround seems to be working.
The cuts at Teva have started to chip away at that massive debt load. By the end of 2019, various layoffs and CAPEX cuts are expected to save the firm about $3 billion in operating expenses. Meanwhile, free cash flows are predicted to jump by 11% to hit a high of $3.8 billion. All of this has helped reduce its debt immensely. After peaking in 2016, total long-term debt at TEVA has fallen by 25% and now sits at just $29.5 billion. Not a small number, but proof that the turnaround is working.
TEVA Gets Hit Again
With that, TEVA stock surged — more than 20% from this year’s lows — on a wave of optimism and Buffett’s buying. Moreover, analysts are now predicting that the drug maker may actually be able to start paying a token dividend again based on its results.
The problem is, the government may be throwing a huge wrench into TEVA’s turnaround.
One of the reasons for the increased cash flows at Teva is that generic drug prices have started to rebound. That’s great news when combined with the operating cuts. However, the Feds aren’t too happy with the “why?” According to a new report in the Washington Post, the government has probed generic drug manufacturers in running a cartel dubbed “The Sandbox” in which executives at drug producers ate lavish steak dinners and fixed prices on more than 300 generic drugs. The 16 firms accused include some of the biggest in the industry: Mylan, Dr. Reddy’s Laboratories (NYSE:RDY) and of course, TEVA. In a court filing, Teva said that the allegations of a price-fixing conspiracy “are entirely conclusory and devoid of any facts.”
The problem is, the lawsuit and probe are a big deal for TEVA on a number of fronts.
Teva’s whole turnaround is built on improving cash flows and it needs as much cash as it can get its hands on. Fines and penalties will reduce the amount of cash it has to work with and pay down its mega-sized debt load. That will push back its turnaround far down the runway. And we don’t exactly know what/how regulators are going to act in the lawsuit. According to the probe, some generic’s — such as Mylan’s asthma medication — surged more than 3,400%. But even small amounts over several years could equate to billions of dollars. Investigators could be going for the jugular here.
Meanwhile, any restrictions on generic pricing models could limit the growth potential at Teva and its peers. Again, hitting its cash flows and turnaround plans.
No wonder why shares of the firm dropped more than 5% when the news broke.
TEVA Stock Might Be A Hold
The question is, is Buffett buying and should you be as well? While the effects of the lawsuit could be years away, it’s a huge risk to Teva’s bottom line and ability to get its cash flows moving again. That’s a problem as it’s the main thesis for the stock right now. And with the probe really getting started, there could be much more downside still left in TEVA stock as new information is made public.
With that, Teva may be a solid hold and a future watchlist candidate.
The turnaround is working and can work, as long as regulators don’t hit it too hard in the probe. But would-be investors may have a better entry point in the future as fines or an outcome is known. All in all, Teva has hit a few more bumps in the road on way to being a top pharma again.
Disclosure: As of the time of writing, Aaron Levitt held a long position in AGN.