Streetwise
Lauren Rudd
Sunday, January 26, 2014
A Possible Ugly Duckling
In the story of “The Ugly Duckling” by Hans Christian
Andersen, a homely little bird matures into a graceful swan. The story comes to
mind once again because of Teva Pharmaceutical Industries (Teva), an “ugly
ducklings” that just might mature into a beautiful swan in the ensuing year or
two. See what you think.
Teva's shares recently hit a one-year high, rising 4.6
percent to $45.45 after the manufacturer of generic pharmaceuticals indicated it
plans to return to the deal-making strategy that made it one of the most
acquisitive drug companies of the past decade.
“We have to do the clever deals that Teva was so good at
doing in the past,” Chief Financial Officer Eyal Desheh said recently. Desheh’s
tone signaled a major shift in approach from Teva’s former chief executive
officer, Jeremy Levin.
Erez Vigodman is the new CEO and one of his key
responsibilities will be to reduce costs by $2 billion to make up for this
year’s patent expiration of Copaxone, the company’s top selling treatment for
multiple sclerosis.
Although having Copaxone coming off patent protection is an
issue, it is not a death blow. Teva has received positive comments from analysts
who see on-going potential and have raised their target price, while the Soros
Fund increased its equity stake in the company.
So what do so many others fail to grasp? For one, Teva is the
world's largest generic company with an established specialty portfolio of
medications. Therefore, Teva is strategically positioned to benefit from the
changing dynamics of the global healthcare industry as it shifts from patented
to generic medications.
Generics accounted for 51 percent of Teva's total annual
revenue in 2012. In the United States, Teva accounts for about 16.2 percent of
all generic prescriptions. And Teva's specialty pipeline includes candidates
that focus on central nervous system and respiratory drugs, along with a
selective innovation of products in the areas of oncology, women's health, and
biologics.
Yes, there is a major concern over the patent expiration of
Copaxone in the coming months. Yet, ProAir and Qvar are expected to add
significantly to revenues. Teva also plans to enhance its existing brands, while
developing products for Asthma and COPD with differentiated inhalers.
Teva has a solid respiratory pipeline with the recent FDA
filing for approval of DuoResp, while a number of products in Phase II and III
testing are designed to treat asthma. Approximately 8 percent of the US
population suffers from asthma and the number is growing. Successful entry in
this arena will significantly add to revenue and earnings growth.
Teva trades at a conservative 9.72 times 2014 earnings.
Revenues for the first six months of the year came in at $9.82 billion; down 2.7
percent year-over-year. Earnings fell from $1.72 billion to $178 million on the
back of $1.62 billion in settlement, impairment and restructuring charges.
Teva’s guidance has 2014 revenues at around the $20 billion mark, while 2014
non-GAAP earnings are estimated at between $4.85 and $5.15 per share.
The patent expiration of Copaxone could put $4 billion of
revenues at risk. Yet, the nearly $2 billion in planned cost savings and an
increased generics pipeline have the potential to overcome that problem.
Nonetheless, two issues merit consideration, the restructuring and legal
expenses that are inherent in Teva's focus on generics, and the level of debt.
However, the company’s net debt position remains high and I
would like to see the gap between GAAP and non-GAAP earnings narrow through a
reduction in one-time expenses.
The intrinsic value of the shares using a discounted earnings model with an
earnings growth rate of 9.37 percent is $40 (not surprising given the earnings
decline), while the more conservative free cash flow to the firm model yields an
intrinsic value of $98.25. My earnings estimate for 2014 is $5.00, with a
12-month share price estimate of $50 for a 10 percent capital gain. There is
also an annual dividend yield of 2.5 percent.