Tempted by TEVA (TEVA Pharma)

– TEVA Pharmaceutical Industries (TEVA) is the world’s largest generic drug company.  Based in Israel and sold here as an ADR, TEVA makes generic and branded drugs with its more than 400 generics accounting for 67% of the company’s $13.8 Billion sales in 2009.

– Last year, 61% of its sales were in North America, 24% in Europe, and 6% in Latin America and Mexico.

– The company operates in over 60 countries with 38 finished dosage manufacturing sites in 17 countries, 15 R&D centers, and 21 Active Pharmaceutical Ingredient (API) manufacturing sites around the world.

– Its API business, which supplies ingredients to TEVA and to its competitors, provides vertical integration to the company.

Company Background:

 – According to Morningstar, four companues account for nearly half of all generic drug sales:  TEVA, Sandoz (a subsidiary of Novartis AG), Mylan (MYL), and Watson (WPI). 

 ** Mstar concluded that TEVA was the leader because it had more than double the revenue, broad market coverage, a “massive manufacturing infrastructure, and vertically integrated operations.”

** TEVA stands to earn significant profits in the near term by making new generics as a large number of patents expire in the next few years, such as the widely used cholesterol drug Lipitor.

– Mstar also found that TEVA’s branded drug Copaxone is the world’s leading treatment for multiple sclerosis and accounts for almost one fourth of the company’s gross profits.

** But, Copaxone’s patent expires in 2014 and, even though TEVA is developing an oral MS drug, so are several other drug companies.  Mstar seemed uncertain about TEVA’s long term prospects.

– In October, Value Line reported that the FDA has approved a new, oral MS drug which could threaten TEVA’s most lucrative drug, Copaxone, which is injected.

** However, TEVA plans to introduce a low-dose form of Copaxone and is developing its own oral MS drug..

 ** TEVA also has some 200 generic drug applications as of July pending FDA approval.  And, it also has several late-stage, branded drugs in development.

** VL reported this July that TEVA has plans for additional acquisitions and for increasing its sales to $31 Billion in the next 5 years, a growth goal of 125%.

Legal Matters:

 – In May, TEVA was odered to pay $356 Million to someone who had contracted Hepatitis C from a vial of the company’s sedative drug, propofol.

** TEVA plans to appeal and has also announced that it will stop making the drug which is one of the most common anesthetics in the U.S.

** The New York Times reported in May that TEVA had to stop propofol production last year and recall some of the drug due to “serious manufacturing violations” according to the FDA and is facing numerous money damage lawsuits.

– TEVA has a reputation as an aggressive litigator in numerous patent disputes.  It not only waits for a patent to expire, it also researches possible defects in other company’s patents and, most aggressively, will market some new generic drugs before FDA approval and risk money damages if TEVA  loses its patent challenge. 

Recent Acqusitions:

– Unlike drug companies that grow through R&D, TEVA also grows by acquisition and has the resources to do so, largely from the cash generated by Copaxone.

** Earlier this year, TEVA bought ratiopharm, Germany’s second largest drug maker, for about $5 Billion in cash and debt.

** In 2008, TEVA bought Barr Pharmaceuticals, a rival generic drug maker, for $7.5 Billion.

** In 2008, TEVA also bought Bentley Pharma for $366 Million and CoGenesys for $402 Million.  Bentley was a generic drug maker in Spain and CoGenesys specialized in biogenerics, a new growth area for TEVA.

SSG Discussion:

– The table below compares the SSG by GeneS, which I got from BI’s First Cut page, with two of mine and with Take Stock.  Armin-1 uses S&P data while Armin-2 uses Hemscott-Morningstar data, while both use the same judgments.

– After the table, I discuss several SSG issues as well as TEVA’s Pre-Tax Profit Margin and Return on Equity, and its Financial Condition. 

TEVA Pharma           (TEVA)	GeneS	Armin-1	Armin-2	Take Stock
Date	10-15-10	11-4-10	Same	11-3-10
Data	S&P	S&P	Hemscott -Morningstar	Hemscott-Morningstar
Price	$54.70	$50.63	$50.81	$50.93
52 week High &             Low Price	$64.85 & $46.99	Same &            Same	Same &            Same	Not Used
Last Quarter of Reported Data	Q2 ending        6-30-10	Q3 ending       9-30-10	Q2 ending        6-30-10	Q2 ending        6-30-10
Software Used	TK 6	Same	Same	TS Online
Project Growth      From End of	Last Q	Same	Same	Last FY
Sales Growth	14.00%	10.00%	Same	17.70%
EPS Growth	13.00%	10.00%	Same	-0.70%
High PE	19.8            (last 4 yrave)	18.8            (from 2009)	19.3                     (from 2009)	21.9
High EPS	$6.37	$6.06	$5.48	$2.19
High Price	$126.10	$113.90	$105.80	$61.74               (44% < VL)
Value Line Estimated High Price = $110-135 as of 7-16-10 and on 10-15-10
Low PE	13.6                    (last 4 yrave)	Same                 (from 2009)	14.2                   (from 2009)	18.3
Low EPS	$3.39                 (TTM)	$3.12                  (Same)	$3.40                 (Same)	$2.81
Low Price	$43.50              (PVQ)	$32.80              (Ave Low      Last 5 yrs)	$35.10                (Same)	$42.78              (Low PE x         Low EPS)
Upside/Down	6.4	3.5	3.5	Not Used
Total Return	18.9%	18.5%	17.0%	4.80%
SSG Buy Under	$57.93	$53.08	$52.78	$32.11
RV/PRV                     (no outliers)	N/A	80.8/73.3	Same/Same	Not Used
RV/PRV                           (2005 out)	98.8/86.8	75.0/68.0	Same/Same	Not Used
Quality	N/A	S&P = None	TS = 2.10 (fails)	TS = 2.10          (fails)
PTPM – 5 yr ave	24.5%               Trend down	Same                 Same	21.6%              Trend down	21.6%              Trend N/A
ROE – 5 yr ave with   Ending Yr Equity	N/A	14.3%               Trend even	13.3%                Trend up	Not Used
ROE – 5 yr ave with   Beginning Yr Equity	17.3%                Trend down	Same                Same	16.3%                Trend even	16.3%               Trend N/A
Debt to Equity –          5 yr ave	30.3%                Trend down	30.5         Trend down	31.1%                Trend down	Not Used

Estimating EPS for the Mext 5 Years:

– Gene estimated 14.00% EPS which, according to his First Cut write-up, was more conservative than his Preferred Procedure, Implied Growth Rate, and Analyst Estimates which, he wrote, were all estimating 14.00% (there seems to be a typo someplace).

– When I did my SSG on 11-4-10, the five analysts I checked were closely estimating long-term EPS at an average of 14.11% with Reuters high at 14.89% and S&P low at 13.80%.

** Zacks.com was 13.57%, Value Line was 14.00%, and YahooFinance was 14.31%.  Reuters’ nine analysts ranged from a low of 9% to a high of 23.10%.  CNNMoney and Morningstar, which usually make a long-term estimate, made none.

** I decided to project 10.00% EPS, close to the very lowest of all analyst estimates (9.00% by one analyst at Reuters).

Forecast Low Price:

 – Gene chose the Price Variant Quotient option ($43.50) for his Low Price estimate, one of six choices offered by our SSG software, which he said was conservative compared to the main option for growth companies ($45.00 from Low PE x Low EPS).

– I chose the most conservative option, the Average Low during the last 5 years ($32.80 for Armin-1 and $35.10 for Armin-2).

Final Results:

 – Gene’s SSG began with a 14.00% estimated EPS and easily satisfied the SSG Buy criteria with a 6.4 Upside/Downside Ratio and 18.9% Total Return.

– My SSGs began with a 10.00% estimated EPS and also easily satisfied the Buy criteria with a 3.5 U/D and 18.5% TR (with S&P data) or 17.0% TR (with H-M data).

** My Forecast High Price also satisfied another demanding standard that I add which is to never substantially exceed (or fall below) Value Line’s estimated High Price.

– Just about any sensible SSG should satisfy the Buy criteria, I think, due primarily to TEVA’s 10% price drop YTD in 2010.

– Take Stock began with a -0.70%  estimated EPS for the next 5 years (that’s a negative .70%) and that is not sensible.

 Pre-Tax Profit Margin (PTPM) and Return on Equity (ROE):

PTPM:

– TEVA’s 5 year average PTPM is trending down which can be a red-flag warning sign of deteriorating fundamentals or, on the other hand, an indicator that the company has an unsustainably high average.

** With Hemscott-Morningstar data, TEVA’s PTPM is markedly better than its industry average (21.6% vs 15.9%, Drug Manufacturers-Other Industry) and ranks sixth out of 80 companies.

** With S&P data, TEVA’s PTPM is also better than its industry average (24.5% vs 20.9%, Pharmaceuticals Industry).  There is no company-by-company listing so no ranking is possible.

ROE:

** With H-M data, TEVA’s ROE with beginning year equity is better than its industry average (16.3%, trending even vs 14.8% Drug Manufacturers-Other Industry) and ranks 11^th out of 80 companies.  With ending year equity, its ROE is slightly worse than the industry average (13.3% vs 14.8%), but more importantly this ROE is trending up.

** With S&P data, TEVA’s ROE is much worse than its industry average (17.3%, trending down with beginning year equity and 14.3%, trending even with ending year equity vs. 41.6% Pharmaceuticals Industry average). 

### I suspect that the S&P Industry Average is distorted by one or more companies with an abnormally high ROE since the H-M Industry Average is so much lower.

Conclusions re PTPM and ROE:

– I am not bothered by TEVA’s downtrend in PTPM because it is better than its Industry Average with H-M AND with S&P data.

** Moreover, Morningstar reports that “Teva’s profitability is consistently higher than that of its generic competitors,” largely due to its higher-margin branded drug portfolio.

** And, the downtrend began in 2008 with its Barr purchase when PTPM sunk to 8.5% (with H-M data) but then rebounded almost all the way back to 20.3% in 2009.

** TEVA’s latest annual report explains that its higher tax rate in 2008 was mainly due to a non-tax deductible write-off of in-process R&D related to the company’s acquisitions of Barr and Cogenesys which reduced its pre-tax income.  See:  TEVA’s Annual 2009 12-K Report to the SEC, page 49 (PDF page 52).

– TEVA’s downtrend in ROE with S&P beginning equity also is not troubling because H-M data shows an even trend AND because the downtrend seems like an anomaly compared to the three other ROE trends. 

Financial Condition:

– When I did Armin-1, its S&P data showed that TEVA had some $7.2B in Total Debt, a Debt to Total Capital Ratio of 26.8%, and a 5 year Debt to Equity Ratio of 30.3% that had dropped to 22.4% in 2009.

 ** According to “Company Debt” by Ann Cuneaz (slide 26), BI Courses To Go, she recommends that the Capitalization Ratio or Debt to Total Capital Ratio should be less than 35% [TEVA’s was 26.8%];

** Debt To Equity by Jim Hurt (slide 13), BI Courses To Go, recommends a Debt to Equity Ratio of below 50% for non-financial companies [TEVA’s 5 year average was 30.3% and 22.4% in 2009].

– Value Line gave TEVA an “A” for Financial Strength and, as of June 30, reported that the company had $4.9B in Cash and $7B in Debt ($5B Long-Term) with LT debt dropping to an estimated $4.4B in the next 3-5 years.

– Morningstar found that TEVA’s management had maintained a conservative Debt to Equity Ratio of .3 or 30%, an Interest Coverage Ratio consistently in double digits, and that the company had about $2B in Cash as of July 7.

– The Bob Adams one-click Annual Report spreadsheet gave TEVA a 74 out of 100 with 9 Bullish results (good things) and 8 Bearish (not-so-goods):

** The Bullish results include: Debt is decreasing and Interest Coverage at 10.6x gets a green flag which is very good; Debt to Equity at 22.0% is also very good; Sales are increasing and Free Cash Flow Margin at 15% is very good.

### If Interest Coverage is under 5, Bob cautions, it is a warning sign to investigate further; if under 3, he urges moving on [TEVA’s was very good at 10.6 times earnings]. 

### Free Cash Flow Margin over 10 is great, Bob says, and substantially over 10 is excellent [TEVA’s was 15%].

** The Bearish results include: Accounts Receivable and Shares Outstanding are increasing; ROE at 10.4% is inadequate and gets a yellow, caution flag; and the Cost of Sales is up 28% and gets a red-flag danger sign.

** You can get a free copy of this easy-to-use Excel spreadsheet and a summary of its many features by going to my Favorites Page at my SSG Blog: click here. 

Armin

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