Teva (NYSE:TEVA) may be up over 60% from its 52-week low, but Teva stock is not out of the woods yet in terms of its headwinds.
High debt, its exposure to the opioid crisis, as well as its current price-fixing scandal, offer investors a cocktail of risk. Certainly, the market has priced these risks into shares.
Yet, valuation-wise, shares aren’t exactly cheap. Despite these headwinds, shares trade at higher Enterprise Value/EBITDA ratio than generic drug peer Mylan N.V. (NASDAQ:MYL). So, what’s the play with Teva Pharmaceuticals? With the recent run-up, it’s clear the easy money’s already been made.
Positive developments could push shares higher. Short interest is not particularly high. On the other hand, upside looks like a challenge. Until TEVA can resolve both its debt and legal issues, expect the stock to stay in limbo.
A strong market could also be propping up Teva stock. With these factors in mind, let’s dive in, and see why TEVA is a hot mess best avoided.
Just When I Thought I Was Out…
Last fall, opioid-exposed drug makers thought they had a solution to their legal liabilities. Teva Pharmaceuticals partnered with Johnson & Johnson (NYSE:JNJ) and three other defendants to cut a deal with prosecutors across the country. In this deal, the company would only get a slap on the wrist: $250 million cash, along with $23 billion worth of opioid addiction-treatment drugs over 10 years.
But state and local prosecutors said, “no dice.” This settlement required sign-on en-masse from thousands of legal eagles. Very few seemed willing to settle. Despite the push-back, CEO Kåre Schultz remained confident sign-off would happen by the end of 2019.
But hindsight is 2020. Literally. This year, state and local attorneys general are going in for the kill. Federal prosecutors will join in as well. Teva Pharmaceuticals may have thought they were out, but prosecutors pulling them back in. And why not? The opioid crisis is red meat for attorneys general looking to make a name for themselves.
Investors have deluded themselves into thinking the opioid crisis is priced into shares. Pay a little fine, give out some suboxone, everything’s copacetic. But given how things are playing out, expect the worst until a new settlement proposal is on the table.
But that’s not all! Back in December, InvestorPlace’s David Moadel broke down Teva’s exposure to a generic drug price-fixing scandal. 44 states are going after Teva Pharmaceuticals and other generic producers. Their goal? To claw back billions that resulted from the collusion.
There’s no ballpark estimate for this liability. But the last thing Teva stock needs is another anvil over its head. Add in a high debt burden, and the company remains a minefield.
Can TEVA Get Its House in Order?
It’s tough to quantify the legal liabilities hanging over Teva stock. But we can quantify their heavy debt burden. As of September 30, 2019, TEVA had around $27 billion in outstanding debt. In the short run, Teva may be okay in terms of refinancing or paying off debt coming due. Thanks to free cash flow generation, along with a recent refinancing, they have the funds to retire maturing debt.
Analyst consensus does not project revenue or earnings growth over the next year. But if Teva Pharmaceuticals can hold steady, they could generate the cash flow necessary to continue whittling down outstanding debt.
To move the needle, the company needs to bring cash flow back to prior levels. A small bump up in sales, along with continued cost reduction, could achieve this goal. Doing this will bring their head above water. With more cash to pay down debt and handle legal liabilities, Teva stock could skyrocket.
Yet, at the current valuation, this upside could be priced into shares. As mentioned above, shares trade at a higher EV/EBITDA ratio (8.7) than peer Mylan (EV/EBITDA of 6.7). Both companies trade at similar non-GAAP price-to-earnings (P/E) ratios. Teva stock trades for 4.1 times forward earnings. Mylan trades for 4.7 times forward earnings.
Once legal risks are mitigated, the company could even benefit from multiple expansion. The big pharma names trade at EBITDA multiples above 10. I don’t see shares trading at a premium to these names, but the discount should tighten once investors are more confident in Teva’s future.
Take Your Time Before Buying TEVA Stock
This year could make or break Teva stock. If the company can handle its debt load and settle legal liabilities for as little as possible, shares could skyrocket. Conversely, shares could fall back to prior levels (around $6/share) or less, if legal liabilities are greater than estimated.
With shares rebounded, now may not be the time to enter Teva stock. Wait to see how upcoming opioid trials play out. If shares pull back to prior price levels, a buying opportunity may emerge. But for now, the risks do not match up with potential upside.
As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.
