Introduction

Two years ago, I wrote an article about Teva (NYSE:TEVA). Back then, the price was around $55, and it rose all the way to $69 six months later. Since then, the stock price has plunged all the way to the current price of ~$32. That’s the lowest price since 2006. Many investors believe that Teva now offers a buying opportunity, but I am afraid that they were those who thought it was attractive when it traded for $55.

The risks that Teva has to deal with are still here. They have actually grown larger. At the same time, new risks emerged, and the current management is unable to deal with them. There is a huge cloud over Teva, and as an investor, I hate those uncertainties.

The growth opportunities are far from being enough to compete with those risks. Moreover, the company still cannot show any new solid path for growth and expansion. We keep hearing the same music. Growth through acquisitions sounds great, but we just cannot see it.

Teva Pharmaceutical develops, manufactures, markets, and distributes generic medicines and a portfolio of specialty medicines worldwide. It operates through two segments, Generic Medicines and Specialty Medicines. Teva Pharmaceutical Industries Limited was founded in 1901 and is headquartered in Petach Tikva, Israel.

Fundamentals

Teva suffers from deteriorating fundamentals. Its earnings are declining, and according to analysts, they will only start to recover in 2019. The company is unable to take advantage of its acquisitions. We see that earnings are eroding, and that is while Copaxone is still protected by some patents, and accounts for over 20% of earnings.

While revenues grow due to acquisitions, Teva still doesn’t manage to find the path for organic growth. Sales, just like earnings, are still highly dependent on Copaxone. Copaxone is a drug that will soon face fierce generic competition. It might take several more years, but it will happen, and Teva isn’t ready.

The dividend is another sign of weakness. While Teva used to raise the annual payment every year, it stayed unchanged over the past two years. The reason for that is that the FCF per share is declining as well over the past two years. The company generates less free cash flow, and together with the higher debt, I believe that the balance sheet is not very flexible.

To conclude, when analyzing the fundamentals of Teva, I see a company that due to some management mistakes is now suffering from deteriorating fundamentals in all fronts. It requires some major changes, and as long as there is no permanent CEO who offers a defined plan, I don’t see any change in the short or medium term.

Valuation

The valuation is the only bright side at the moment. Its P/E ratio is very low at 6, and even the forward P/E is extremely attractive around 6.5. However, as you know, there is no such thing as a free lunch, and this attractive valuation comes with some major risks.

TEVA PE Ratio (Forward) data by YCharts

The figure above might be very misleading. The trailing P/E only takes into consideration the EPS of the past, and the future P/E shows declining EPS. Even the optimistic analysts believe it will decline, and I will list the risks, so you will understand why I am pessimistic, and believe that the actual EPS might be even lower going forward.

If you think that the management team will turn the ship around this year or next year, you should consider Teva as a value play. However, I believe that the situation will be worse before it gets any better. The risks and headwinds that Teva has to deal with promise the company a very bumpy ride.

Opportunities

Teva does have some advantages that might be able to offer growth opportunities in the future. Firstly, its size offers an advantage. It is the largest generic drugs company in the world. Moreover, due to its acquisitions, it has access to most markets around the world using local companies that were integrated into Teva.

While Teva still has to deal with the patent cliff regarding Copaxone, it is still protected in the short term. Moreover, even when the patent expires, creating a generic drug is not simple at all. Even when generic drugs are introduced, the decline in sales will be gradual, thus giving Teva some more time to adapt.

Moreover, at the current share price, Teva has a very low market cap of $32 billion. Even when the company was trading for $55, there were rumors that it is targeted for acquisition. Two years ago, it was Pfizer (NYSE:PFE) that could initiate a takeover according to rumors. Right now, any of the pharmaceutical giant can acquire Teva and turn to the largest generic drug company in the world.

If an acquisition happens, it will probably be for a higher share price, and the management team of the acquirer will have to confront the problems that Teva suffers from. Yet, the opportunity to become a generic giant may be tempting for major healthcare companies.

In August, Allergan (NYSE:AGN) will sell the 100 million shares of Teva that it owns. While there might be some selling pressure, there is also the opportunity that an active investor will purchase at least some of them, and they will try to promote a change in Teva that will unlock some value to the shareholders.

Risks

While Teva has some growth opportunities, the risks are overwhelming. Firstly, the debt level keeps growing with each acquisition. In 2015, I was worried with $10 billion of long-term debt. Today, this number has passed the $30 billion. The interest payment in a rising interest rate environment will have its toll on the FCF, and the balance sheet will be even less flexible.

The acquisitions that Teva has made should have helped in growing FCF, so the larger long-term debt won’t be as dangerous as it is right now. However, the integration wasn’t always smooth and comfortable. Moreover, it is much harder to find attractive companies to acquire.

Right after the financial crisis, Teva acquired several companies for attractive prices. Yet, today it is much harder to find an attractive candidate, and even when you do find it, they don’t want to be acquired like in the case of Mylan (NASDAQ:MYL).

Copaxone is defended by patents that are challenged in courts all over the world. While the delay tactics does work at the moment, and I believe that the decline in sales will be gradual, there is still no major blockbuster that Teva can offer in the medium term. There are several drugs in development, but none is forecasted to be as meaningful as Copaxone.

An activist investor purchasing the 100 million shares from Allergan can be a good sign. However, if they are sold in the open market, there will be massive sell pressure that will have a negative influence on the share price. You might see the stock price plunge in even more by August 2017.

Another risk that Teva will have to deal with is the regulation. It got a large fine from the regulators. It settled the corruption charges by paying over $500 million. While this investigation is over, Teva will now be checked thoroughly, and if any other corruption charges are filed, it might have to pay more fines like that one.

The management team that has to deal with all these risks is not stable at all. Over the past five years, Teva had five different CEOs, and the company is looking right now for a new CEO. When a company is managed like that, it is impossible to create a long-term vision and execute it. It made even the institutional investors in Israel, who usually have a lot of confidence in Teva, worried.

Conclusion

While Teva does have some opportunities, the risks are immense. It is almost impossible to avoid all of them, as some of them have already emerged, and Teva is suffering from those right now. I believe that investing in Teva today is very risky, and worst is yet to come.

If you do wish to invest in Teva, you can write put options for January 2018. I find the strike price of $25 or $27.5 attractive. You can collect the premium, and you would only have to buy the shares if they reach that price, which I find to be attractive. I will only buy Teva if the P/E stays attractive even if the GAAP EPS declines by 33%. Therefore, at the mid $20, I will consider buying Teva, as it will offer an attractive valuation that suits its current condition.

The combination of high debt, lower FCF, management that so far was unable to come up with a clear plan for growth, and doesn’t react well to the risks, together with Copaxone patent cliff, makes Teva unattractive. If I owned it, I would have sold it. If you don’t own it, I’ll advise you to avoid it. I was negative on Teva in 2015, and I am still negative on it in 2017.

Disclosure: I am/we are long PFE, JNJ.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



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