Don't Quit on Teva Just Yet

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Feb 20, 2014

Teva Pharmaceuticals Industries Ltd. (TEVA, Financial) is a global pharmaceutical company committed to the development, manufacture and marketing of both branded and generic drugs, as well as active pharmaceutical ingredients (APIs) in North America, Europe, Latin America, Asia and Israel, where it is headquartered. Right now, Teva is going through a transition period, and this year will be a challenging year for the company. The company is expected to face new and harder competition for branded products, and could start facing generic competition for one of its star drugs, Copaxone, prescribed for multiple sclerosis, which would eventually cut earnings by 60 cents and revenues by $500 million.

Furthermore, fewer generic launches are expected prior to Copaxone's patent expiration. Recently, also, shares of Teva went down about 1% after the company disclosed a federal investigation into its marketing practices. Copaxone, along Azilect, used in the treatment of Parkinson's disease —Â and both its primary money-makers —Â will be the drugs in question during the investigation which will track down events back to 2006. In spite of this it is most likely to come to a settlement. In case of wrongdoing being found, it may not be the best time for the company to financially face it. Doubts are raised. How strong are Teva's strategy and financials? Is it time yet to quit on this stock? Let's take a closer look at its situation and find out.

The Obvious Risks of Clinical Development, Generic Competition and Dependency

Recently, Teva has provided an update on its pipeline, but details and clarity regarding its candidates in development remain awaited. However, the company has stated that it expects to have 10 new therapeutic entities approved for development each year. It noted that clinical development and trial involve a high degree of risk, and gaining approval for pipeline candidates has become more difficult due to a tough regulatory environment. Nonetheless, Teva has currently several programs in its pipeline that increase its focus on central nervous system (CNS) and respiratory disorders, and new therapeutic entities. One of its new drugs — Laquinimod — recently failed to meet clinical endpoints in its Phase III multiple sclerosis trial. However, Teva is still pursuing approval of the drug for indications in Crohn's and Huntington's disease.

There are no doubts that the pharmaceutical industry in which Teva operates is highly competitive. Teva faces competition in both the generic and the branded market. In this last segment, it faces it from other pharmaceutical players depending on product categories. Copaxone, Teva's lead branded product, does so from existing products such as Avonex, Betaseron, Rebif, Extavia and Tysabri, as well as other newly launched drugs that have raised competition in Teva's main market — multiple sclerosis.

The generic market is also crowded and companies are constantly striving to be the first ones to launch a generic version once a brand product loses exclusivity in order to rapidly capture a significant market share. For a company like Teva this means that once one of these generic companies enters the market, market share, revenues and gross profit most likely will decline. But since Teva also operates in the generic market, it is important that it manages to develop and introduce new products in a timely and cost-effective manner to maintain revenues and gross profit. In this regard, the firm faces considerable competition from low-cost producers in emerging markets, such as India, which threaten Teva's dominant position. However, as the largest pharmaceutical manufacturer with vertically integrated operations, the company has both the scale and resources to help minimize the threat of low-cost producers in emerging markets. And if that wasn't enough to offset — or at least minimize — the threat of generic competition and dependency, Teva is also one of the very few generic firms that own the financial resources and manufacturing capabilities to reproduce complex drugs, such as biosimilars and respiratory inhalers. Given this, the company has said it is determined to pursue first-to-file and first-to-market opportunities and seek approval for complex generics, which are likely to face less competition.

Strong Strategy and Financials

There is also the fact that Teva is the world's largest generic company in both terms of total and new prescriptions. It enjoys a leading position in the US, and is working on strengthening its position in Japan —Â the world's largest second pharmaceutical market —Â along with key emerging generic markets, where generics penetration is low and growth and profitability potential high.

However, the company is right now going through a transition period due to fewer large generic opportunities, potential new competition for branded products and a higher cost base. In order to improve its position the company has designed a strategy. All in all, it intends to accelerate growth platforms, protect and expand core franchises, expand its global presence, pursue strategic deals, divest non-core assets and reduce the cost base. This last Teva will accomplish through a cost-savings program which is expected to deliver of about $2 billion by the end of 2017.

Truth is, that in spite of all this problems and the transition, last year Teva's stock climbed nearly over 18 percent. As it seems, the appointment of a new CEO has inspired some renewed trust in the stock, and investors have come to terms with the eventual loss of Copaxone, as Teva's pipeline, acquisition efforts and cost-saving plan, combined with this drug's manufacturing difficulty, will most likely help insulate earnings from a potential generic Copaxone approval. Although it may not be the best time for the company to face a federal investigation, if the time comes to reach a settlement, it will not destroy the company financially.

 Teva Pharmaceuticals Industries Ltd (TEVA, Financial) Industry Median Takeda Pharmaceutical Co., Ltd (TKPYY, Financial)
P/E 31.3 26.90 36.8
Mkt. Capital 44.26 B - 37.18 B
ROE 5.6% 6.80 4.5%

Still not a stock trading at a large price premium, you might as well have some time to take a long position on it. Vanguard Health Care, George Soros (Trades, Portfolio), James Barrow (Trades, Portfolio) and Michael Price (Trades, Portfolio) have already done so.

Disclosure: Victor Selva holds no position in any stocks mentioned.