Is Teva Making a Comeback?

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The recent rally in shares of Teva Pharmaceutical Industries (NYSE: TEVA) may suggest investors are regaining some confidence in this pharmaceutical manufacturer. Will Teva’s upcoming second-quarter financial report, which will come out on August 1, show signs of recovery? Will it surprise investors? Is it worth having this giant generic-drug manufacturer in your portfolio?

Generic medicine sales are falling

One of the biggest hits Teva has taken so far this year is the sharp drop in generic sales in the U.S:  Sales dropped by nearly 27% in the first quarter of 2013 compared to 2012. The generic segment accounts for 47% of the company’s revenue. In comparison, during the last quarter of 2012, the generic segment accounted for 51% of total net sales. The decline in the generic segment’s sales out of total sales is likely to persist as competition in the generic market keeps intensifying.

At least in Europe, the competition hasn’t adversely affected the company’s revenue as in both the specialty and generic segments, sales rose by 9% and 21%, respectively. But the ongoing slowdown of the European economy may eventually catch up with Teva and curb its revenue growth in that region.

In 2013, the company projects to reach annual net revenue of about $10.5 billion in generic segments. Based on the first-quarter financial report, the company’s annual net sales may reach only $9.2 billion, which is 12% lower than the company’s 2013 outlook. Therefore, unless generic sales start to pick up in the coming quarters, the company won’t meet its projections.

In the meantime, Teva didn’t do well in the courts: Teva, along with Sun Pharmaceutical, will pay Pfizer (NYSE: PFE) approximately $2.1 billion for settling a patent suit. Teva lost in a recent lawsuit in which it sued Mylan for infringing its patents for treating multiple sclerosis. These lost lawsuits and settlements are likely to adversely affect the company’s financials.

Specialty medicine isn’t doing well either

The situation in specialty medicine isn’t much better as Teva’s net sales inched down by 0.3% in the first quarter of 2013 (year-over-year). The drop in sales is mostly related to the sharp decline in Provigil sales due to generic competition. Despite the recent drop in sales, the company’s gross income (excluding MS treatment) in the specialty medicine segment is close to other companies that are leading the way in specialty medicines. The chart below compares the gross profit margin of leading pharmaceutical companies in the past couple of quarters.

Pfizer’s gross profit margin is nearly 85%, which is close to Teva’s gross profitability. Merck's (NYSE: MRK) profit margin is much lower at 74%.

Moreover, in the specialty medicines business segment, companies such as Merck and Pfizer haven’t done much better in terms of revenue growth in the first quarter of 2013:  Pfizer’s revenue declined by 12.4%; Merck’s net sales fell by 9% (year-over-year).

Pfizer's drop in sales was partly related to the U.S government purchase of Prevnar 13 and loss of exclusivity and near-term expiration of Aricept and Spiriva, respectively. These factors are likely to further diminish Pfizer's revenue in the future. Merck's decline in revenue was also due to patent expiry of Singulair and other treatments. This trend is also likely to continue in the coming quarters, which may pressure Merck's stock price.   

Therefore, at least in the specialty medicines segment, Teva’s profit margin and revenue growth (or lack of it) isn’t much different than other leading specialty medicines companies.

Research & development continues to rise

In the first quarter of 2013, Teva’s R&D provision for specialty medicines rose to 10% compared to the first quarter of 2012. Nonetheless, other specialty medicines companies continue to allocate a larger portion of their revenue towards R&D as indicated in the chart below.

Pfizer’s R&D as percent of revenue reached 13% in the first quarter of 2013; Merck’s ratio is the highest of these three companies at 17%. Moreover, Merck slightly increased its R&D provision, which will help the company develop new treatments and thus reach growth in revenue in the future. Pfizer’s R&D as a percent of revenue remained nearly the same compared to the first quarter last year. Looking forward, the company may need to allocate more funds towards R&D in order to augment its revenue.

One of the reasons for Teva’s lower R&D-to-revenue ratio is its R&D allocation for generic drugs (roughly 38% of the company’s R&D is allotted toward generic drugs.) If Teva’s R&D-to-revenue ratio in the specialty medicines segment remains, the company’s potential growth in the future is questionable. 

Dividend

Teva’s rise in dividend payment pulls its annual yield much closer to companies such as Pfizer and Merck. Teva’s current annual yield is nearly 2.8%. In comparison, Pfizer’s yearly dividend yield is 3.3%, and Merck’s annual dividend yield is 3.6%. Therefore, even though Teva has a large generic-business segment that has a much lower profit margin, its dividend yield isn’t much lower than specialty medicine companies such Pfizer and Merck. 

The bottom line

Teva hasn’t done well in the first quarter, and based on the above, the company isn’t likely to show signs of recovery in the coming quarters. Nonetheless, the company’s lack of growth in revenue is common in the pharmaceutical industry. Moreover, its reasonable profit margin and dividend yield compared to other leading pharmaceutical companies suggest that the company isn’t doing much worse than companies such as Pfizer and Merck. But even so, I don’t think Teva is a company worth having at this point, and I doubt if the company will surprise its investors in the coming quarters.

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Lior Cohen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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