A cheap entry into Pharma and OTC

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

Teva Pharmaceuticals (NYSE: TEVA) is one of the most underappreciated stocks in the market. The company has shown solid growth in both generics and branded segments, but the stock has still depreciated.

The OTC growth has also been phenomenal, and the company is poised to hit the $1 billion mark in OTC sales. Teva is currently trading well below mean sell-side estimates, and offers an attractive entry point to investors. A primary investor concern is the low dividend yield. I believe this concern is invalid, because Teva is still a growth stock, and I believe Teva is a strong buy at these levels.

Teva Pharmaceuticals
Teva Pharmaceuticals is one of the world’s largest generic drug manufacturers. The company manufactures and sells generic drugs for various ailments, in the form of capsules, ointments, creams, tablets, injectables, inhalants etc. Its primary branded products include Copaxone, Provigil, Nuvigil, Azilect, Qvar etc. The company has faced declining sales from its major braded Copaxone, due to increasing generic competition. The maturing market for its products has been one of Teva’s primary concerns. As can be seen in the figure below, the revenue growth has taken a hit due to this slowdown.

The market was expecting Teva to increase its dividend yield or buyback program, in the recent investor conference. To investor disappointment, the company didn’t announce any new dividends or buybacks; the stock plummeted after the webcast. I believe Teva was at a juncture where it could either have decided to accept its mature status and focus on returning maximum wealth to shareholders, or focus on finding new ways to drive growth. Therefore the webcast was kind of an announcement that the company was focusing on driving revenue and EPS growth. The future of Teva’s stock price is tied to the success of company’s management in effectively executing the plans announced during the webcast.

TEVA data by YCharts

Strategic Shift

The new strategy of Teva is to diversify its business and ensure that it doesn’t face fears of collapsing revenues, as it does upon Copaxone’s patents expiry. The company announced the three key steps in its bid to diversify its business model and drive growth:

  1.  Branded Segment: In the branded segment the company plans to focus on ‘Central Nervous System Disorders’ and ‘Respiratory Diseases’.  It plans to develop existing molecules on the unique device that Teva has in-house i.e. the Spiromax.

  2.  Over the Counter: The OTC segment has shown phenomenal growth over the last couple of years. The company has more than $600 million in OTC sales, in the last 3 quarters. TEVA is relying on its venture with Procter & Gamble Co. (NYSE: PG) to drive its OTC growth. The industry is expecting that Teva’s OTC share will grow beyond the $1 billion mark by year end. According to both companies, the total peak sales potential of this partnership is beyond the $4 billion mark.

  3. New Therapeutic Entities: TEVA plans to integrate its generic and branded capabilities to formulate new products called NTEs. According to the company:

    ‘these are new therapeutic entities, known molecules that are formulated, delivered, used in novel ways, sometimes combined to address specific patient needs. So we would look at the unmet need, think about known molecules many, for example, in our branded or in our generic pipeline that we're using, and then think about novel approaches, novel indications, novel delivery, novel formulations or combinations and this represents the fundamental basis for the development of NTEs’


    If the company is successful in its NTE strategy, it can be revelation for the entire industry. It would enable Teva to not only save big time on R&D, but also create products with high sales potential.

Conclusion
The stock is currently trading at a P/E of 7, which is almost 70% below the industry average P/E of 24. The sell side has a mean target price of $46, varying between $55 and $41. Therefore the stock is currently trading at a 20% discount to its mean target price, and 10% discount to its lowest target price.

The valuations show that Teva is selling at a significant discount right now, which make it look like a buy to me. With the OTC growth and the company’s venture into NTE, the future seems bright for TEVA investors.

Alternate Thesis

The primary concern for Teva investors should be the low dividend yield and payout ratio of 2.2% and 32%, respectively. The stock has depreciated more than 20% in the last five years, and with a low dividend yield, it remains a risk for investors to own Teva. The promise of NTE can also face regulatory headwinds in the future. Any concrete conclusion can only be drawn once more information is made available.  


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