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Leigh Baldwin & Co.

112 Albany Street, Cazenovia, NY 13035 | Phone: (315) 655-2964 Toll Free: 1-800-659-8044

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Stock of the Week

Teva Pharmaceuticals

May 16th 2016

Teva Pharma
Industry: Generic drugs
Price as of 5/15: $50.30


The market fell once again this week for the third straight week. The markets had their chance to break out to new highs in April, but came up short. Now the major averages are in a 3% correction. The Dow and S&P 500 are barely positive for the year. Many sectors continue to struggle. Retail is taking it on the chin as it seems more consumers are gravitating their spending online to Amazon and less to the brick and mortar stores. Speaking of Amazon, the company is firing on all cylinders with the stock breaking out to new all-time highs with a market cap over $300B. To put things in perspective, Amazon does less than half the sales of Walmart, but has a market cap 64% higher. Facebook is also performing great with a market cap a little higher than Amazon, but just under Exxon Mobil. Google and Apple are jarring back and forth for the largest market cap which means four of the top five market cap US companies are tech related. One sector outside retail that continues to struggle is healthcare. Political pressure to reduce drug prices, government intervention to prevent mergers targeted at moving headquarters outside the US, and of course Valeant Pharmaceuticals and their accounting issues have shied investors away from the healthcare space. A recent featured stock, Allergan is acting much better as they try to distance themselves from Valeant and Valeant's business model. Allergan has a mountain of debt, but luckily they made a decision to reduce their debt by selling their $30B generic drug business to Teva which leads us to this week's featured stock, Teva Pharmaceuticals. Teva like most healthcare stocks has been under pressure not far from a 52 week low. The Isreali based company is already the world's largest generic drug company with a dividend yield of 2.7%. Currently, the stock is trading for less than 10 times forward earnings, a steep discount to both the S&P 500 and the broader pharmaceutical industry. In the short term, investors are concerned about drug pricing, but long term, Teva and the rest of the space provides good risk reward for shareholders with a long term horizon.  

Two weeks ago Teva beat reduced earnings and sales estimates for the first quarter. Granted, Teva is facing increasing competition in its generic drug business. Per share profit, excluding certain items, dropped to $1.20 from $1.36 last year as revenue fell 3.5% to $4.8 billion. Still, the numbers exceeded the $1.17 a share profit and $4.77 billion in revenue expected by analysts. Going forward, Teva forecasted that second quarter earnings would be between $1.16 a share and $1.20 a share. That straddles the $1.18 a share Street estimate. Branded drugs account for more than half of Teva's revenue. Those sales rose 10% during the first quarter. But with cheaper-priced copies of branded drugs, also known as generics, making up roughly 48% of Teva's annual business, the company fell victim to worries about profit growth amid struggles by rival drug makers. Granted, Teva's generic revenue has fallen for the past several quarters, dropping 17% during the first quarter to $2.2 billion amid the loss of market exclusivity for its generic versions of the asthma mediation Pulmicort and the heartburn drug Nexium. Once the Allergan acquisition closes in June, generic sales will account for two-thirds of Teva's top line. But going forward, Teva sees a different pricing picture. Teva told investors in a conference call today that it does not expect the drop in generic drug prices in the U.S. to deepen. The unit gross margins remain high and stable at 46% which is good news for shareholders.

To be sure, generic drug prices could surprise investors negatively. And the 2016 presidential election campaign will likely keep pressure on the entire pharmaceutical industry, but Teva's valuation reflects a lot of the negativity already. Currently the stock trades for 10 times earnings, 8 times 2017 earnings, and 1.8 times sales with a dividend yield of 2.7%. Earnings and sales are expected to pick up in the next year or two due in part to the Allergan generic drug buyout. If Teva can keep meeting Wallstreet expectations, investor concerns should subside and the stock should move higher once again.