Go Against The Crowd With This Pharma Giant

Benjamin Graham, the father of value investing, is quoted as saying, “in the short term, the market is a voting machine, but in the long term, it is a weighing machine.”

Now, the quote doesn’t appear in Graham’s famous book, The Intelligent Investor. But according to Graham’s star pupil, Warren Buffet, Graham taught the concept to students at Columbia University. And given Buffet’s unimpeachable character, the statement stands on its own.

But even if the quote isn’t exact, the principle is…

#-ad_banner-#You see, the voting machine is a popularity contest based on beliefs that may or may not be true. Our recent presidential election is a great example of how other people’s perceptions influence our decisions. But at the end of the day, they’re mostly a set of opinions and expectations. This makes them untrustworthy.

In contrast, Graham’s weighing machine implies that investment decisions are objective decisions — based solely on data gleaned from company reports and financials. This leads investors to use things like earnings reports to make decisions. And earnings are the single best predictor of stock performance.

Today, we’re going to heed Graham’s advice and go against the perceptions of the crowd with generic drugmaker TEVA Pharmaceuticals (NYSE: TEVA).

Teva is most widely known as a generic drug-maker based in Israel. The company dominates the generic drug industry.

It dominates about 8% of the market — almost twice that of its next closest competitor, Novartis (NYSE: NVS). The company produces roughly 73 billion pills annually while filling more than 4.2 million prescriptions daily in the U.S. and Europe.

But that will change in the future…

On August 2, 2016, Teva closed a deal to buy Actavis Generics — the generic division of drug-maker Allergan (NYSE: AGN) — for $40 billion.

This is a game changer for TEVA. The company now owns the rights to drugs like Botox, Namenda (a billion-dollar Alzheimer’s drug), and cyclosporine (a billion-dollar immune system drug also known as Restasis).

The combined company now owns more than 16,000 different products across its portfolio, including its specialty division. The company’s specialty division provides name-brand drugs for multiple sclerosis, Parkinson’s disease, pain abatement, and cancer.

The company has more than 300 abbreviated new drug applications (ANDAs) on file with the FDA. This makes TEVA a huge potential beneficiary of President-elect Trump’s promised regulatory reforms.

One-third of its ANDAs are for so-called first generic drugs, or drugs that are the first version of their branded counterpart. These “first-wave” drugs tend to be highly profitable over the short term.

But perhaps the biggest driver of the company is its influence with distributors. The sheer size of the combined company gives TEVA the ability to set its prices with all the major players like Cardinal Health (NYSE: CAH), AmerisourceBergen (NYSE: ABC), Walgreens (Nasdaq: WBA), Rite Aid (NYSE: RAD), CVS (NYSE: CVS), Target (NYSE: TGT), and Wal-Mart (NYSE: WMT).

This is important.

You see, the QuintilesIMS Institute for Healthcare Informatics recently announced that it expects the generic drugs market will expand at a compound annual growth rate of more than 10% from 2016 to 2020, and constitute roughly 92% of all medications dispensed by 2020. And as the world’s largest generic drug provider, TEVA is perfectly situated to profit from the rapidly growing elderly populations in the developed world.

Investors Continue To Ignore TEVA
Despite the strength of the combined company, TEVA shares have been punished by investors as illustrated in the chart below.

Why The Punishment?
It seems that the biggest reason for the stock price getting cut in half is the market’s uncertainty surrounding the drug Copaxone. Copaxone is an injectable multiple sclerosis drug that faces increased competition from orally administered therapies and a competing generic version.

And this is a legitimate concern.

You see, Copaxone is expected to generate approximately 15% of TEVA’s revenues and one-third of its operating profit. And its patents on the drug were supposed to be protected until 2030.

But Mylan (Nasdaq: MYL) filed a petition with the Patent & Trial Board, which invalidated three of TEVA’s patents for the drug. That has scared Wall Street off the drug-maker resulting in a 43% decline in the stock price YTD.

But Wall Street’s fears are overblown…

Over the past 12 months, TEVA booked $19 billion in sales. It earned $11.2 billion in gross profit and $2.5 billion in net income. And the company collected $4.2 billion in free cash flow — nearly double what it took in 2013.

Revenue growth has slowed recently, but that’s likely to reverse once merger synergies and tax benefits accrete to the bottom line in 2017.

Going forward, TEVA expects net sales of $21.9 million in 2016. This includes diluted non-GAAP earnings per share of $5.10 to $5.20. Next year’s consensus earnings estimate is $5.91.

While future estimates may be revised downward due to the Copaxone litigation, the stock maintains significant value despite the increased leverage associated with the Allergan acquisition. Still, the company’s strong balance sheet helped it secure debt financing at an average interest rate of 2.17%.

TEVA is fundamentally attractive. The company is valued at just 6.3 times next year’s consensus EPS — its lowest level since the company went public. In addition, the stock maintains a healthy 3.7% dividend yield.

Given these facts, now is the time to bet on this generics giant. And if Benjamin Graham were still alive, I think he might agree.

Risks To Consider: On December 6, it was announced that the head of the company’s global generics unit, Siggi Olafsson, plans to retire at the end of the first quarter of 2017. This, in combination with pending litigation surrounding some of the company’s existing products, could extend the timeline of any price appreciation.

Action To Take: Buy Teva Pharmaceutical up to $40 a share. Use a 25% hard stop to protect your capital and stick to a position-size of no more than 2%-3% of your portfolio.

Editor’s Note: In the last few years they’ve seen gains of 296%… 545%… even as much as 696%! But a single new technology is poised to make 2017 their biggest year yet… Full story…