This Well-Known Blue Chip Stock is Now on Sale
There are stocks you can buy, and then there are stocks you just admire. These “admirable” companies are strong operators, generating consistent annual growth and always finding new paths to growth. But since they perennially perform so well and are so deeply admired by investors and analysts alike, you can rarely buy them at a bargain price. Instead, you can only admire them. Lucky for us, a bargain has just emerged.
#-ad_banner-#I have been following Teva Pharmaceutical Industries (Nasdaq: TEVA) for some time, first interviewing the company’s then-Chief Financial Officer, Dan Susskind, for an article back in 1998. Teva was the third-largest maker of generic drugs at the time, and it is now the world’s leading player, with an 18% share in the United States. To complement its generic drug business, Teva started to develop its own branded drugs, with the most notable success coming from Copaxone, a drug that treats the symptoms of Multiple Sclerosis (MS). Copaxone has gone on to become a blockbuster, now for roughly one-third of Teva’s profits.
Yet Copaxone is also why of Teva are in the doghouse currently, having fallen from the $60 in late March to a recent $46. Biogen Idec (Nasdaq: BIIB), a competitor in the biotech space, announced that a newly-developed MS drug known as BG-12 has shown to be even more effective in clinical studies than Copaxone. If all goes according to plan, BG-12 will hit the market in late 2012 or the first half of 2013. If that happens, then sales of Teva’s Copaxone would lose its dominant market share.
Yet investors are missing one important point. Losing market share is inevitable: Copaxone loses its patent protection in 2014 anyway, a fact the company had already been fully prepared for some time. Analysts at UBS have long assumed Copaxone would generate roughly $2.60 in earnings per share (EPS) for Teva in 2013, dropping to $1.08 a share in 2016. After Biogen’s drug was announced, analysts have become locked in a debate over whether Copaxone will still throw off such earnings in 2016 or if Biogen’s drug will secure the whole market, pushing Copaxone sales to zero.
Management has been well aware that Copaxone is approaching the end of an era and has been pursuing several tracks to rebuild sales and profits. One of those attempts involved Laquinimod, which could have picked up a decent share of the MS market, which had proven to be even more effective in clinical trials than Copaxone and had many years left on its patent. Now, the betting is that Biogen Idec’s BG-12 will prove to be the biggest drug in the space. That remains to be seen. It’s just too soon to declare Laquinimod a loser in this race.
Moving away from the MS opportunity completely, Teva is ready to take aggressive moves to boost sales and profits. For starters, it has signed a far-reaching deal with Procter & Gamble (NYSE: PG) to join forces to make and sell all of P&G’s over-the counter drugs outside of North America.
Each company brings plenty to the table: Teva has strength in global distribution, R&D, regulatory dealings and manufacturing. From a regional market perspective, Teva is strong in places like Russia, while P&G is strong in places like India. At the retail level, Teva has deep ties to drugstore chains, while P&G is strong in many other retail channels. The deal won’t bring an immediate boost to profits, but it could become significant within a few years.
Teva is also beefing up spending to develop drugs in the area of women’s health and has an active slate of generic drugs it will pursue once their branded counterparts lose patent protection within the next 24 months. The loss of market share in the MS space has perhaps caused investors to overlook an otherwise robust franchise. (Teva’s generic drug business accounted for roughly 70% of the company’s $16 billion in revenue last year.) As analysts at Needham recently noted, “We continue to believe recent weakness tied to annihilation of expectations for oral MS agent Laquinimod present an excellent accumulation opportunity for investors with 12-month plus investment horizons.” They see rising from a current $46 to $65.
Analysts at UBS concur: “Eventually, we think investors will look at the underlying fundamentals and realize that the free cash flow (FCF) build up at this company is significant, that it’s mergers and acquisitions track record is pretty good and that Copaxone is probably worth more than nothing.” Free cash flow has indeed been phenomenal, topping $4 billion in 2010 and its likely to be even higher in 2011.
Of course, the eventual loss of Copaxone is bound to hit Teva’s free cash flow, perhaps by 25-30%. Analysts at Israel-based Meitav think declining sales for Copaxone in coming years “is increasing the pressure on management to make large acquisitions.”
Action to Take –> Teva is in transition. In the next few years the company will be selling internally-developed or acquired drugs to help to make up for the hole Copaxone will create in the business. With shares at a 52-week low and not far from where they stood five years ago, it’s hard to ignore a glass half-full view.
Management is expected to broadly discuss all of these issues when first-quarter results are discussed in early May. In light of the recent share price slump, don’t be surprised if Teva announces a large stock buyback program. It may not immediately boost the stock, but could help to sharply lower the share count ahead of Teva’s next growth phase.
The stock trades for just around nine times projected 2011 EPS and just nine times projected 2012 profits. This is the lowest forward multiple the stock has had in the past 10 years — by a considerable margin. Perhaps this stock doesn’t deserve to trade for 15 or 16 times forward profits anymore, but a forward multiple in the very low teens makes sense in light of management’s stellar track record that extends back to 1901. By my math, I see 25-35% upside from current levels.
P.S. — I don’t know if you’re aware of this or not, but a 20-year energy agreement between the United States and Russia is about to expire. The problem is, this deal supplies 10% of America’s electricity. When the Russians refuse to renew the agreement, the U.S. will face an entirely new kind of energy crisis. This disruption could send a handful of energy stocks through the roof. Keep reading…