It is perhaps a little ironic that generics giant Teva Pharmaceutical (NYSE:TEVA) finds itself in a position similar to what it helped create for many other pharmaceutical companies over the years. The company is facing increasing competition for its blockbuster MS drug Copaxone, while also having to deal with more pushback on pricing and a thinning pipeline for major generic releases. While Teva does have to face up to some near-term challenges, success with biosimiliars and a decision from management to double-down on internal efficiency and profitability would likely go a long way toward improving investor sentiment.
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Some Good, Some Bad, with Third Quarter Results
Teva gave investors a mixed performance for the third quarter. Sales and gross margin came in a little light, but lower operating expenses helped cushion the blow.
Reported revenue rose 14% for the third quarter (with flat sequential growth), as the contributions from the Cephalon acquisition boosted results. Organic revenue growth was more on the order of 1%. Teva saw generic revenue increase just 1%, while branded sales growth of 38% was led by the inclusion of Cephalon drugs like Provigil, Nuvigil and Treanda, and better-than-expected growth (up 13%) in Copaxone.
While gross margin was slightly disappointing, it nevertheless improved on both a GAAP and adjusted basis; GAAP gross margin improved about a half-point, while adjusted gross margin improved more than two points. Operating income rose 6% on an adjusted basis, as lower-than-expected R&D and SG&A spending helped the company's reported results.
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Even Generics Aren't Immune to Price Pressure
Part of the bullish thesis on generic drug makers like Teva, Mylan (Nasdaq:MYL) and Watson (NYSE:WPI) has been that their cheaper drugs are the answer to tighter national healthcare budgets. While it is true that Teva seems relatively better positioned than branded companies like Pfizer (NYSE:PFE) or Lilly (NYSE:LLY), tighter spending nevertheless limited growth in Europe to just 1%, and revenue did decline 8% on a sequential basis.
Remember, generics don't generally launch at their final price. There are benefits to being the first to launch a new generic drug, and companies like Teva are often able to charge 50% or more of the branded drug price before new entrants push the price down. So a combination of fewer launches (particularly exclusive launches) and more price resistance from national healthcare systems can be problematic for these companies.
Teva Has Some Changes to Go Through
Part of the bullish thesis on pharmaceutical companies like Pfizer, Merck (NYSE:MRK) and Sanofi (NYSE:SNY) is that they've largely gone through the worst of their patent cliffs and corporate restructurings. In the case of Pfizer and Merck, for instance, there have been substantial layoffs and corporate restructurings (including divestitures like Pfizer's sale of its nutrition business).
Now it's Teva's turn.
The company's OTC drug partnership with Procter & Gamble (NYSE:PG) has already been pretty successful, and I would be surprised if the company didn't look to pursue this even further. At the same time, however, I would expect Teva's new CEO to launch a company-wide restructuring aimed at streamlining manufacturing and improving margins.
Last and not least, Teva needs to reinforce Wall Street's confidence that biosimilars will be a meaningful boost to revenue over the next decade. The company recently got FDA approval for tbo-filgrastim, and while this is not technically a biosimilar to Amgen's (Nasdaq:AMGN) Neupogen (Teva filed for approval before the FDA created the new biosimilar pathway and submitted a full BLA), I expect analysts and investors will be looking at this as a test-case for new biosimilars.
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The Bottom Line
There's still quite a bit of uncertainty as to just how much new MS drugs from Biogen Idec (Nasdaq:BIIB) and Sanofi will impact Copaxone revenue and how much impact biosimilars will have at the top and bottom lines. Consequently, there's a pretty big spread between analyst estimates for 2015 to 2017. While that uncertainty increases the risk, it also paves the way for the shares to outperform if Teva can deliver solid financials.
I do believe that Teva can continue to grow its free cash flow, as I think there is room for improvement in the company's manufacturing and sales processes. That said, companies like Merck, Pfizer and Sanofi seem to offer almost as much upside (if not more) as Teva, and a lot of the execution risk is behind them. So while I am basically bullish on Teva at these prices, it's not my best or favorite idea in drugs or healthcare today.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.
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