Teva: Why Analysts Love This Stock

Ryan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Profitability, Growth, and Market Share Leadership

Analysts have followed and loved this stock for the past few years because of its market leadership, high margins, profitability, dividend, and potential for growth.  Many analysts are bullish on the Healthcare Sector because (1) more and more people are living longer; (2) more people need treatment; and (3) as emerging economies grow you tend to see more jobs in the service sector and more disposable income flowing into healthcare.  Teva (NYSE: TEVA) is well positioned to capitalize on all of these trends.                 

Teva is penetrating markets in the world’s strongest economies such as Germany, the UK, Japan, and the United States.  Teva has also established footholds to grow alongside maturing and emerging markets.  The company has, however, learned that it must not focus on market share leadership at the expense of profitability.  In Europe, for example, Teva has prioritized profitable, sustainable growth over market penetration and share leadership. 

Acquisitions That Make Sense

Teva appears to have a very well thought out growth plan.  In 2008, Teva acquired Barr Pharmaceuticals, a global specialty pharmaceutical company that operated in more than 30 countries.  Then, in 2010 Teva acquired Ratiopharm, Germany’s second largest generics producer and the sixth largest generic drug company in the world, which greatly expanded its coverage throughout the European Union, particularly in countries like Germany, France, Spain, and Italy.  That same year Teva also announced that it intended to build a distribution center – and potentially a headquarters – in the Philadelphia area. 

In 2011, Teva purchased Cephalon, which greatly expanded its presence in the proprietary pharmaceutical sector.  The acquisition of Cephalon reinforced Teva’s long-term strategy of building out its branded and specialty pharmaceuticals business through diversification and expansion of its product portfolio and pipeline, while enhancing its position as a worldwide leader in generics. 

A few months after that Teva purchased Taiyo Pharmaceuticals – the third largest generic drug company in Japan.  The acquisition of Taiyo provides Teva with access to the second largest pharmaceuticals market in the world, valued at over $100 billion.  That acquisition provided Teva with access to a strong R&D team, local regulatory access, and a state of the art production facility – and it ensures that Teva will become a leading player in the world’s second largest pharmaceuticals market. 

What are the Key Risks?

The major risk that Teva faces is ensuring that it is in compliance with the plethora of different governmental regulations.  Noncompliance increases the probability that business operations will be disrupted.  In 2011, for instance, Teva closed its production facility in Jerusalem because of a warning letter that it received from the FDA.  The company also had to temporarily suspend its operations in Irvine, California.  So Teva has had to shut down a plant at least twice – and that is just what was reported in the news.  Noncompliance also increases Teva’s exposure to legal claims.       

Teva has sought to strategically diversify its portfolio through mergers and acquisitions.  That strategy seems to have worked out well for Teva.  At this juncture, however, we cannot tell whether or not Teva overpaid for these companies, whether or not Teva will realize significant cost savings, and whether or not Teva attempted to do too much too soon.  In the near future,  I wouldn’t be surprised if Teva were to announce that it was going to ‘focus on core competencies’ or if Teva’s new CEO were to centralize manufacturing – similar to what he did at Bristol-Myers Squibb.       

What is a Fair Valuation?

Teva currently has a forward Price to Earnings Ratio of around 7, which compares favorably with companies like Eli Lilly (NYSE: LLY) and Watson Pharmaceuticals (NYSE: ACT).  Eli Lilly has a forward P/E ratio of slightly more than 13, while Watson Pharmaceuticals has a forward P/E ratio of a little over 10.  Eli Lilly, a fairly stable company, has a dividend of around 4%, while Watson Pharmaceuticals, a company with considerably higher growth expectations, does not currently pay a dividend.  Teva is comparable to Watson Pharmaceuticals, and I believe that fair market value is currently around $45. 

3 Reasons to Consider Purchasing Teva

1.  Considering Teva’s rate of growth, future profitability, reasonable dividend (around 2.75%), and level of product diversification, it appears as though Teva’s shares are currently oversold.

2.  Teva has several drugs awaiting FDA approval, and Teva will benefit from the ‘patent cliff’ at Big Pharma companies through 2015 when it flattens out.         

3.  Teva appears to have a very well thought out growth plan that now focuses on profitable growth rather than on gaining market share.           

My Foolish Take

On the negative side, Teva has a declining return on equity, which is currently at less than 10%.  That points to difficulty managing through recent M&A activity.  Increased leverage has resulted in operating shortfalls.  The largest concern with Teva, however, is that in its most recent quarter it posted a loss.  For some investors, that raised concerns about the company's stability. 

On the positive side, Teva is attractively valued given its underlying fundamentals.  In addition, Teva has a very solid growth strategy and a diversified product line.  In the long run, the most recent quarterly earnings might merely represent a blip on the radar.    

On balance, I feel that Teva is oversold and that purchasing the stock in the $35 – $37 range provides a reasonable upside (15% - 30%) with minimal downside risk.  In the near future, if Teva delivers against earnings forecasts it might increase its dividend.  That would signal that Teva’s operations have stabilized and that the company believes that its shareholders benefit more by increasing the payout rather than investing those dollars back into the company.

RyanPeckyno has a position in Teva. 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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