Teva Pharmaceutical Industries Ltd. (NYSE: TEVA). The company has faced numerous challenges over the past several years, including the loss of exclusivity on key drugs, price erosion in the generics space, and various legal issues, which have led to steep discounts in the stock price. While the company addressed some of these challenges through restructuring in 2019, the COVID-19 pandemic has largely halted the stock’s recovery, with the shares trading nearly 30% below their February 2020 highs. Management also believes that the company has moved past the bottom of its self-declared ‘trough’ and is making progress on gross margins. As such, we believe that Teva is well positioned to achieve full-year earnings growth in 2020, and that the stock merits a higher valuation.
The beta on TEVA is 1.08.
The shares have lagged due in part to headwinds in the generic pharmaceutical industry and the accumulation of lawsuits related to alleged price fixing and the opioid epidemic. In relation to the generic industry, manufacturers had been hurt by price erosion, a marked reversal from several years ago when they were able to raise prices on an annual basis.
Teva reported 2Q20 results that beat earnings expectations, marking its third consecutive quarter with above-consensus adjusted earnings. On August 5, Teva posted non-GAAP EPS of $0.55, down from $0.60. The decrease in revenue was driven mainly by lower revenue from generics, OTC, and Copaxone in all regions, lower revenue from QVAR and Bendeka/Treanda in North America, and the impact of COVID-19 on purchasing patterns. These negatives were partly offset by higher revenue from Austedo, Anda, and Ajovy in the U.S.
The company has had several positive pipeline developments over the last few months. With regard to Ajovi, a treatment for adults with migraines, Teva announced new results from a post hoc analysis of a long-term, open-label extension study on October 7. The results showed consistent frequency of migraine days at the beginning and end of the dosing period, an important distinction as many preventative migraine medications can lead to a worsening of symptoms before the next dose is due. Earlier, on September 15, the company released long-term data regarding the safety of the migraine treatment, which showed no clinically significant patterns of adverse effects or any instances of serious adverse effects from the injection. In late July, the company also filed for approval of the product in Japan.
It has also announced positive news with regard to its portfolio. On October 2, the company launched the first FDA-approved generic versions of HIV-1 treatments Truvada and Atripla in the U.S. For reference, there are currently roughly 1.2 million people in the U.S. with HIV-1. On September 21, the company launched two digital inhalers, the AirDuo Digihaler Inhilation Powder and ArmonAir Digihaler Inhilation Powder, in the U.S. for patients with asthma. The two new inhalers, which contain build-in Bluetooth wireless technology, automatically detect and store inhaler use data. They can remind patients how often the devices have been used and determine if the inhalation technique needs improvement. The recent approvals round out Teva’s Digihaler portfolio, following its July 13 launch of the ProAir Digihaler in the U.S.
Regarding partnership developments, Teva announced a strategic partnership with Alvotech on August 5 in which the two companies will collaborate to expand their presence in the U.S. biosimilar market.
Following the 4Q19 completion of the company’s restructuring plan, Teva began a long-term gross margin improvement program. It is also targeting a 2023 operating margin of 28%, a cash-to-earnings ratio of more than 80%, and a net debt/EBITDA ratio of less than 3. Teva is committed to using cash flow to pay down debt.
EARNINGS & GROWTH ANALYSIS
Teva reports results for three primary segments: North America (53% of 2Q revenue), Europe (26%), and International Markets (13%). Other activities represented roughly 9% of 2Q revenue. Second-quarter results for these businesses are discussed below.
In North America, revenue fell 1% to $2.05 billion. The segment gross margin rose 180 basis points to 53.3%, reflecting a more favorable product mix, while the profit margin rose to 28.0% from 24.3% a year earlier. Total segment profit rose 14% to $573 million.
In Europe, revenue fell 15% to $1.00 billion. The gross margin fell to 54.7% from 56.9% a year earlier, primarily due to lower sales of certain specialty products, while the profit margin fell to 24.3% from 26.7%. Total segment profit fell 23% to $244 million.
The International segment (i.e., markets excluding North America and Europe) saw revenue fall 16% to $488 million.
The guidance assumes continued price erosion for Copaxone, with projected sales of $1.2 billion; and growth for Ajovy and Austedo, with sales of $250 million and $650 million, respectively.
Our estimate implies increased adoption of recently launched products and an increase of 8% from our 2020 forecast.
FINANCIAL STRENGTH & DIVIDEND
We believe that it may take some time before the company resumes dividend payments.
MANAGEMENT & RISKS
Kare Schultz has been Teva’s president and CEO since September 2017. Mr. Schultz had previously served as CEO of the Danish pharmaceutical company H. Lundbeck. Eli Kalif serves as EVP and CFO, having joined the company in December 2019 following the retirement of Michael McClellan. Mr. Kalif previously held various leadership and senior finance management positions at Flex Ltd., a global technology design and manufacturing service provider.
Risks for Teva include competition for Copaxone and ProAir following the loss of market exclusivity for both products. In addition, price erosion has been a headwind for Teva.
Management noted that overstocking of medicines in the first quarter had changed supply dynamics, leading to lower sales in the second quarter, and can disrupt forecasting. The pandemic has also impacted the company’s clinical studies, in some cases leading to issues with patient recruitment or the postponement of certain trials. Furthermore, management has noted that sources of certain raw materials are concentrated in a few countries, and that a resurgence of the virus in these countries could lead to supply shortages.
Teva also faces a number of legal and regulatory risks. On August 25, the company was charged by the U.S. Department of Justice with three counts alleging price-fixing, bid-rigging, and the allocation of consumers in conspiracy with other manufacturers. Each of the charged offenses carry a statutory maximum penalty of $100 million, while the maximum fine may be increased to twice the gain derived from the crime or twice the loss suffered by the victims of the crime if either amount is greater than $100 million. Teva had walked away from settlement negotiations with the DOJ in May 2020, confident that the department would not levy charges given the company’s work in combating the pandemic. We are watching developments in this case, and will update our analysis as more details emerge.
Teva has also been ensnared in multiple lawsuits related to the opioid epidemic. The company proposed settling these cases in October 2019, offering to pay $250 million and supply $23 billion of treatment drugs over the course of ten years. While investors reacted positively to the settlement, as the 10-year timeframe would give Teva ample time to pay its claims and the quantity of treatment drugs was based on the drug’s list price rather than its production cost, several state governments were unhappy with the proposal. Teva had been scheduled to face another opioid-related lawsuit in New York in March 2020, although this was postponed due to the pandemic.
Teva Pharmaceutical Industries is the world’s largest generic pharmaceutical manufacturer, with roughly 120 billion tablets and capsules produced annually. The company has over 40,000 employees and a presence in 60 countries. One of every nine generic prescriptions in the U.S. is filled with Teva products.
From a technical perspective, the shares appear to have stemmed their recent decline, rising nearly 15% since late September. Fibonnacci retracement level near $11 per share, which largely corresponds to its lows in June and July.