If Teva Pharmaceutical Industries Ltd (ADR) (TEVA) Stock Looks Cheap, It May Be Cheap for a Reason

Should you pull the trigger on Teva? Guggenheim's Rohit Vanjani is fine staying sidelined.


As a generic drugmaker, Teva Pharmaceutical Industries Ltd (ADR) (NYSE:TEVA) operates in a fragmented industry lacking pricing power, yet must sell into a concentrated industry of drug buyers who do have pricing power. This does not portend good things for the company’s earnings — or its ability to pay down debt — going forward.

In a comprehensive, 109-page report covering the biggest names in specialty and generic drugs, Guggenheim analyst Rohit Vanjani revealed… that he’s got no particular opinion on Teva. Doesn’t like it. Doesn’t particularly hate it either. Basically, after running the numbers, the analyst finds himself feeling pretty “neutral” about Teva  — yet decided to initiate coverage yesterday anyway.

Now why should you care about such a lukewarm report?

Laying out the landscape

On the surface, an investment in Teva looks like a no-brainer. This is a well-known name in the pharmaceutical industry, yet it trades for only a single-digit multiple to earnings — 4.2 times expected 2017 earnings, 5.7 times what Teva is expected to earn next year.

And yet, from a big picture point of view, Vanjani explains that the U.S. drug market is dominated by “an oligopoly” of three “consortiums.” Combining the buying power of such well-known names as Walgreens and CVS, Walmart, McKesson, and others, these three consortia “account for more than 85% of generics purchases in the U.S. market.

While Teva’s customers have consolidated — increasing their buying power and ability to negotiate discounts — Teva and its fellow “pharma/generics manufacturers” have not, and “remain fragmented, and saddled with debt in their attempts to consolidate.” Lacking pricing power, Vanjani believes these manufacturers can only prosper by selling “difficult-to-make products,”  “biosimilars,” or by doing a significant portion of their business outside the U.S.

What it means for Teva

Now, that last bit may incline you to think positively of Teva. After all, Teva Pharmaceutical is not even technically an “American” drugmaker, but an Israeli company. As such, Teva does do a good portion of its business outside the U.S. — from which about 47% of its revenues derive.

Despite this fact, Vanjani is not enthusiastic about the name. Why not? For one thing, the analyst notes that pricing pressure from the buying consortia have resulted in Teva’s drugs falling in price, rather than rising slightly as had been hoped. For another, Vanjani notes that Teva has nearly halved the value of new generic drug launches it plans to make this year. At the beginning of 2017, Teva had hoped to launch new generics selling about $750 million annually. By the end of Q3, that number had fallen to just $400 million.

These factors are cutting into cash flow, and causing worries about Teva’s debt load to loom large. Currently, Teva’s balance sheet boasts cash on hand of just $680 million (and zero long-term investments), versus  a long-term debt load of nearly $32 billion (and “approximately $35 billion” total debt). Teva’s “debt rating and paydown will be a concern in the near term,” warns Vanjani. “Cost-cutting measures and additional divestures” to raise cash and pay off debt “would be positively viewed.”

For now, Vanjani is initiating coverage with a Neutral rating. If Teva makes any moves to significantly whittle down its debt, though, upgrades could quickly follow. (To watch Vanjani’s track record, click here)

Wall Street believes Vanjani is smart to play it safe when it comes to Teva’s prospects ahead, as TipRanks analytics reveal TSLA as a Hold. Out of 18 analysts polled by TipRanks in the last 3 months, 2 are bullish on Teva stock, 12 remain sidelined, and 4 are bearish on the stock. With a loss potential of nearly 12%, the stock’s consensus target price stands at $14.50.

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