Given that the stock has been going down and has returned -6.87% year to date I am going to go back and see if I should add more, stay put or think about exiting.
The Business Teva is a global pharmaceutical giant which combines manufacturing generic drugs with branded medications. With a tailwind of aging populations and many of the bestselling drugs going off patent in the near future, the business is on the upside. In 2011, the company launched 17 generic versions of branded products in the US. Drugs with branded sales over $400 million are shown below. As generic drugs are sold at a much lower prices, the table only gives an indication of the importance of the generic drug.
|Brand Name||Launch date||Annual Branded Sales ($ mil)|
A generic company may be awarded a 180-day marketing exclusivity for being the first generic applicant to successfully challenge a patent. In 2011, the company received 14 tentative approvals. A tentative approval indicates that the FDA will give the final approval as soon as the relevant patent expires, a court decision is reached, a 30-month regulatory stay lapses, or a 180-day exclusivity period awarded to another company expires. Out of these 14 tentative approvals, following are the ones with annual branded sales with more than $400 million.
|Brand Name||Annual Branded Sales ($ mil)|
Teva will also have an exclusive 180 days to sell a copy of Lexapro, a top-seller of Forest Laboratories Inc. (FRX), with $2.3 billion in sales for the fiscal year ended Mar 2011.
Risk: There are two major risks facing Teva’s business. The first is the way Teva sells its products. It sells 43% of its products through drug store chains and 38% through drug wholesalers. A large wholesaler/chain may ask for a lower buy price and can squeeze the margins of Teva.
The second risk is the patent cliff that Teva faces itself. Teva’s 26.2% revenue comes from branded products. Around 20% of the revenue is from Copaxone, an MS drug, which loses patent protection in 2015. Teva is looking for ways to extend the patent until 2030, i.e. by making changes to dosage. I have no idea how successful this will be. Looking for a way to minimize the impact of the patent cliff, Teva bought Cephalon for $6 billion. This was not a great move because Cephalon’s 41% revenue comes from Provigil, a sleep disorder therapy, which loses patent protection next year.
Balance sheet: Teva follows a strategy of growing by acquisitions. In 2011, it made two major acquisitions: Taiyo, the third largest generic drug maker from Japan; and Cephalon, which we talked about earlier. Taiyo cost $1.1 billion and Cephalon $6 billion.
This has made a significant dent in the balance sheet of Teva. Let us look at the LT debt and LT liabilities.
In 2011, the OCF of Teva was $4.4 billion as opposed to $308 million of interest expense in the trailing 12 months. The following is the debt maturity timeline for Teva.
Teva has now $10.2 billion in long-term debt. It has credit rating of A- from Fitch and has a stable outlook. Due to this, Teva has been able to issue cheap debt in 2011. The following is the debt situation of Teva.
Risks: The balance sheet of Teva has deteriorated quite rapidly. In 2009 the LT debt was $4.3 billion as opposed to $10.2 billion in 2011. The equity on the other hand has gone from $19.2 billion to $22.2 billion. Furthermore, the company has $18.3 billion of goodwill and $10 billion of intangible assets on its balance sheet. I don’t really know how to put a price on the patents and “intangible assets” Teva holds. So, it is a fool's errand for me. In any case, I don’t think that we need to look at the apocalypse scenario.
The debt maturity timeline is still mild and the interest is quite well covered with a coverage ratio of nearly 13.
Share count: Teva’s share count has been increasing every year. Let us look at the situation in the last decade.
The share count has gone from 562 million in 2002 to 921 million in 2010. If we look at the stock based compensation expense, then it has been less than $288 million for the last 5 years (2007-2011). So, this does not really explain 359 million increase in the shares outstanding.
Digging into the annual reports, I found out that Teva has been funding acquisitions by selling shares. Here are two examples that I found.
In January 2006, 123 million shares were issued in connection with the acquisition of Ivax.In January 2004, 47 million shares were issued in connection with the acquisition of Sicor.Last year, Teva announced a $3 billion buyback which will be completed in the next three years. It has already started buying back shares and according to the most recent quarterly statement, the share count is 877 million. Given that I think the stock is cheap, this is a great deal for the shareholders.
Management: The last time I covered Teva, Shlomo Yanai was the CEO. Now, Teva has a new CEO — Jeremy Levin. Levin brings a wealth of pharma experience and has been with Novartis (NVS) and Bristol Myers Squibb (BMY).
Levin is going to drive Teva towards growth by focusing on the branded segment of OTC products and is going to pay for some of it by saving costs.
Furthermore, the management has promised to jack up the dividend. The dividend has been going up year after year. Even after the price decrease the dividend is still 2.13%, which is a lot smaller than the average 4% dividend yield of the pharma stocks. With the payout ratio at 32% Teva can keep improving the dividend per share.
Valuation: If you believe that Copaxone’s patent expiration is not going to have a major effect on the profitability of Teva then the shares are quite cheap.
If we look at the FCF of Teva, it has been $3.3 billion in the trailing 12 months. This puts the market cap of $32.5 billion at less than 10 times FCF.
Disclosure: I am long Teva.