Shares of beaten up pharmaceutical giant Teva Pharmaceuticals (NYSE:TEVA) have sprung back to life over the past month, rising nearly 40% from what was essentially a 20-year low price tag for TEVA stock in early October 2019.
Why the big rally? A few positive developments, which broadly underscored that the worst of this company’s crisis may be over. Quarterly numbers came in better than expected. The core generics business is starting to stabilize. So are margins. There’s also been some favorable progress on the opioid litigation front.
More importantly, though, will the big rally in TEVA stock persist?
I think so. Shares remain dirt cheap, and there’s plenty of room for multiple expansion. At the same time, the company appears to be on the cusp of a huge earnings turnaround, and considering how far profits have fallen, there’s plenty of room for profits to run higher over the next few years.
This combination of sustained profit growth and multiple expansion should ultimately keep the rebound in TEVA stock alive for a lot longer.
Shares Remain Dirt Cheap
Central to the bull thesis on TEVA stock is that — despite the 40% rally over the past month — shares remain dirt cheap at current levels.
The numbers tell the whole story here. TEVA stock trades at a lousy forward price-to-earnings ratio of 4. The five-year average multiple on TEVA stock is up around 8. Before the opioid crisis, TEVA stock was trading at multiples around 11 and 12. Today, the whole pharma sector trades at 14 times forward earnings.
Sure, some could argue that TEVA stock deserves this hugely discounted valuation given that revenues, margins and profits have been falling. Plus, the company has been staring at huge opioid litigation headwinds. I agree. So long as those dynamics remain in play, TEVA stock deserves to be cheap.
But, those dynamics are starting to reverse course, and as they continue to reverse course, the multiple underlying TEVA stock will continue to expand.
Fundamentals and Optics Are Improving
At present, all the trends are moving in favor of Teva.
The company’s core generics business — which has been killed over the past few years by a variety of headwinds, including adverse pricing trends, lower demand and some headline risks — is starting to stabilize, with sales down only 2% year-over-year last quarter. This is leading to overall revenue trend stabilization, too, with revenues down just 6% year-over-year last quarter. Assuming these current trends persist, then Teva could be looking at positive revenue growth next year.
At the same time, the expense base has been dramatically reduced, thanks to aggressive cost-cutting measures from management over the past few years to help soothe profit erosion while the generics business tumbled.
Thus, now you have a business with a dramatically reduced expense base, and revenues that are ready to start growing again. The implication? Not only is positive revenue growth on its way, but so is margin expansion. That double tailwind will produce healthy profit growth over the next few years. And that’s a reality which isn’t priced into TEVA stock.
On the optics side, opioid litigation is progressing favorably. Teva settled two suits in Ohio and is making progress on settling many more nationally. The more this headwind moves into the rear-view mirror, the more investors will believe that the growth narrative here is back on track.
Teva appears to be on the cusp of a multi-year profit growth turnaround, and TEVA stock isn’t priced for this reality. This combination means that recent strength in TEVA stock should persist.
Bottom Line on Teva Stock
TEVA stock has been a big-time loser for the past several years. But, this losing streak may be coming to a close. It appears that the long overdue turnaround in TEVA stock is finally here, led by stabilization in the core generics business and progress in opioid litigation.
Considering just how cheap shares still are at 4 times forward earnings, one can reasonably expect that this rebound rally has a lot of firepower left.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.