Is Teva Investing Enough in Its Branded Products?

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In a recent article I argued that Teva Pharmaceutical (NYSE: TEVA) isn't doing well and its revenues are likely to remain flat in 2013. One of the reasons for the lack of growth or potential growth is the company's relatively low Research and Development expense – one of the driving forces that could lead to growth in revenues. Teva's R&D provision as a percentage of its revenues is much lower than other big pharma companies such as Merck & Co (NYSE: MRK) or Pfizer (NYSE: PFE).

The main criticism of the article was that these pharmaceuticals are branded companies while Teva is a leading generic pharmaceutical. Thus, my analysis was comparing apples and oranges. Let me clarify.

Comparing apples and oranges

In my first analysis, I presented the percentage of R&D provision out of total revenues of Teva, Merck and Pfizer. I admit that by making this crude comparison, I took a short cut. So let's take the long route.

First, even though Teva is the top generic company it still has strong branded products such as Copaxone and Azilect. Moreover, according to the company's third quarter report, branded products account for nearly 40% of the company's total revenues. Teva also allocates the majority of its R&D provision to the branded over the generic medicines: "Approximately 62% of our R&D expenditures were for our branded medicines, and the remainder were for generic R&D."

Second, based on these facts and by dividing between revenues from branded and generic products, we can examine the percentage of Teva's R&D provision out of brand, generic and total revenues.

<img src="/media/images/user_12845/teva-rnd-2011-2012-by-sectors_large.jpg" />

The chart above shows that the company's relative R&D expense is higher in branded than in generic medicines. According to this analysis we can now compare Teva's R&D expense in branded medicines to other leading branded companies.     

Comparing apples and apples

The chart below presents the R&D provision as a percentage of net revenues. The chart compares Teva, Pfizer and Merck. For Teva, I have used only the company's R&D provision to braded products out of branded medicines revenues. Despite the adjustments, the analysis still shows that Teva's R&D provision is the lowest of the three companies. 

<img src="/media/images/user_12845/teva-rnd-2011-2012_1_large.jpg" />

What could explain this? No surprise: resources. Purely branded companies have much higher profit margins (no competition), produce many branded products so that the sunk costs are already invested (labs, facilities etc), and have lower financial risk than generic companies (depend which ratio we use).

The table below shows the debt-to-equity of all three companies as of the recent third quarter report.

<img src="/media/images/user_12845/teva-debt-to-equity-ratio-2012_large.jpg" />

As seen, Teva's debt-to-equity is the highest of the three, which could suggest the company's financial risk is higher.

Based on the above, Teva's stock might not grow in 2013. The company isn't expecting to increase its R&D in 2013 so one of the main factors that could lead to a potential rise in revenues will remain unchanged. The company's branded division doesn’t have the same relative resources as leading branded companies, which could explain the company's stock lack of growth.  

For further Reading: Is Chesapeake walking towards the right path?

Disclaimer: The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.


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