Over the past four months, Teva Pharmaceutical (NASDAQ:TEVA) stock has gone up from around $6.5 to a recent high of $11.13. However, despite this recent impressive increase, in the past 12 months, the stock’s price is down close to 50%.
With the company expected to report Q4 earnings on Feb. 12, long-term investors are now wondering if this is a good time to buy the stock. Although it seems like it might be a promising opportunity, I’d suggest that investors wait before buying.
I’d like to see the quarterly results before committing new capital into TEVA stock. Here’s why.
Concerns With Teva’s Financials
Teva is one of the world’s largest generic drugmakers. It also manufactures specialty pharmaceuticals. From humble beginnings in the early years of the 20th century, the Israeli company has grown into a major global player and has even become a source of national pride.
In its Q3 earnings, posted in November 2019, Teva reported revenues slightly over $4.26 billion — a 6% year-over-year decline. This drop in revenue was larger than expected.
Earnings per share of 58 cents also meant a 14.7% YoY decrease. Analysts were expecting 59 cents. Free cash flow for the quarter was $551 million. A year ago, the number stood at 704 million.
Teva reports earnings in three segments: the U.S., Europe and International. As the largest market, the U.S. provides about half of its revenues. Its most famous product is Copaxone, a treatment for multiple sclerosis.
About half of the U.S. revenues comes from generics. Management highlighted that Teva “led the U.S. generics market in total prescriptions and new prescriptions, with approximately 391 million total prescriptions (based on trailing twelve months), representing 10.6% of total U.S. generic prescriptions.”
Kåre Schultz, Teva’s President and CEO, also highlighted how crucial restoring the financial security and stabilizing Teva’s business would be in the year ahead.
Teva has been an out-of-favor drug stock that has languished over the past several years. It has even been named as one of the “biopharmas at high risk of bankruptcy in 2020.” Its market cap is currently about $11 billion. Yet as of September 30, 2019, total debt was $26.9 billion, compared to $28.7 billion as of June 30, 2019. In other words, the company is in distress.
Generics Is Big Business
Generics play an increasingly important part in the pharmaceutical market. According to Thomas Hemphill of University of Michigan-Flint, “among American adults 20 years and older, 59 percent take at least one prescription drug on a regular basis.” And the cost of prescription drugs in the U.S. is an important concern for patients and policymakers.
A recent article co-authored by Robert Califf, MD, of Duke University and Andrew Slavitt highlights that “the generic drug system launched by the Hatch-Waxman Act … of 1984 has been so successful that more than 90% of US prescriptions are now for generics.”
Brand-name drug patents typically last around 20 years. And as a patent expires, other companies can apply for the Food and Drug Administration’s approval to legally manufacture generic formulations. Analysts expect the segment to grow further in 2020 and beyond as more branded drugs come off patent protection.
We all get sick occasionally or have friends and relatives who may need treatments for chronic illnesses. Thus the role played by generic drugs is important. For example, in August 2018, Teva introduced an FDA-approved generic version of Mylan’s (NASDAQ:MYL) EpiPen Jr.
Moreover, according to the Census Bureau, in about two decades, the elderly will outnumber children for the first time in our history. That means the country will need more generic drugs. Therefore, I expect TEVA stock to benefit from the demographic developments. And with a forward price-to-earnings ratio of just over 4, the stock may also appeal to value investors. The generics industry number is generally between 9 and 10.
What Could Derail Teva Stock?
Profit-Taking: If you are an investor who also pays attention to technical charts, the price action in TEVA stock urges caution. In a matter of a few months, the share price has increased about 80%. Therefore, it would be logical to expect some of those investors to ring the cash register. It’s likely that there might soon be a leg down, taking the shares toward the $9 level.
Lawsuits: In 2019, dozens of U.S. states sued 20 pharma companies over price-fixing conspiracy and inflated prices. And Teva Pharmaceuticals was named as the mastermind behind the illegal actions.
The case filed by Connecticut Attorney General William Tong claimed that unlike the usual dynamics of generics marketplace, “prices for hundreds of generic drugs have risen – while some have skyrocketed, without explanation … The size of the price increases varied, but a number of them were well over 1,000%.”
The pending litigation still weighs on the company and many investors may be reluctant to buy into Teva shares before potential liabilities are settled.
Debt issues: In 2016, Teva purchased Actavis Generics for $40.5 billion from Allergan (NYSE:AGN). In hindsight, this acquisition was possibly one of the worst steps the company could have taken. Teva almost went bankrupt. And despite some recent successful moves to increase solvency and cut the debt ratio, it has not yet been able to recover from the debt and the balance sheet is still quite damaged. Long-term debt is still around $24.2 billion.
In July 2015, TEVA stock had seen an all-time high of $72.31. As a result of the debt burden coupled with the legal issues, in August 2109, the stock hit a decade low of $6.07. in other words, this failed acquisition has destroyed much shareholder value.
Many investors feel that a lot of bad news is already priced into the TEVA share price. Yet at this point, I regard it as a risky stock to own outright, at least without a hedge in the options markets.
If you are already a shareholder, it may be time to take some profits. Alternatively, you may want to hedge your long stock position with a covered call or put spread that expires on Mar. 20. That expiration date would give you enough time to evaluate Teva’s upcoming earnings.
In the next earnings report, which will present a complete review of 2019, I’d like to see management release solid numbers and discuss the various issues the company is facing. Otherwise, investor concerns may not be easily allayed.
On a final note, in 2017, management had suspended dividends to be able to pay down the massive level of debt. Although there will likely be investors who would hope the dividend may be back, it is probably too soon for management to take such a bold move.
Although I’m hopeful for the longer-term prospects for Teva stock, I do not think it will be a quick turnaround success. In the meantime, there might be further consolidation in the industry and the company could indeed draw vultures, but it probably would not be easy prey.
As of this writing, Tezcan Gecgil did not hold a position in any of the aforementioned securities.