Investment Thesis

For Teva Pharmaceutical (TEVA), looking ahead, it’s very difficult to build a bullish argument for why this stock is compelling and attractive.

Although I was an ardent bull of this stock in the past, right now I’m now struggling to see its upside potential when we consider the company’s debt profile and lack of strong growth prospects.

Investors should look to reconsider this investment at a lower price point.

Teva Pharmaceuticals - Smart Energy Decisions

Looking Ahead, More of the Same

Teva has been working tirelessly to reduce its debt profile for some time as part of its multi-year turnaround efforts.

(Source: Q2 2020 Investor Presentation)

Accordingly, even though the company carries a large amount of debt, it has been able to chip away at its debt profile.

Above, you can see that its leverage has come down from 5.72x in Q2 2019 all the way down to a more manageable 4.9x leverage in Q2 2020.

Teva’s success in bringing down its debt is driven by its high-profit margins: the company’s EBITDA margins reached 27% in Q2 2020. Also, consider that its cash flow conversion is strong at 79% in Q2 2020.

(Source: Q2 2020 Investor Presentation)

Furthermore, Teva continues to guide investors for approximately $2 billion of free cash flow in 2020.

However, here’s the problem – even if we earmark its price-fixing and opioid scandal lawsuit together at somewhere around $2 billion, which is a low estimate, and push that liability aside, we are still left with a huge stack of debt:

(Source: Q4 2019 Investor Presentation)

The slide above is slightly outdated, given that in July 2020, the company paid down $1.1 billion of its debt. However, this doesn’t substantially change its upcoming debt profile.

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What’s more, as CEO Kare Schultz guides, Teva’s target is to get its net debt profile at less than 3x by the end of 2023. However, as you know, from investors’ perspective, that’s a very long time to wait around for this investment to become attractive once again.

This means that until Teva has brought down its debt profile to 3x net debt, it will not be in a position to pay out any dividends or even to repurchase shares. In fact, there’s often chatter that the company could consider diluting its shareholders – although Schultz consistently argues that it has no need to do so.

Lessons I’ve Learnt From Teva

The two biggest lessons I learned from Teva:

1) Try to avoid sectors that are very competitive. Even though the particular situation matters to each company, having a favorable and expanding market is very helpful.

Put another way, if you have tailwinds to the company’s back is far better than having headwinds.

2) What saved my own capital here, in this case, was that Teva is by far one of the best generic players in the world, and the very cheap price I had bought my shares at afforded me a margin of safety here.

Looking Ahead, Teva Needs More than Stability

(Source: Q2 2020 Investor Presentation)

In the past, I was willing to see past the fact that Teva’s top line was essentially flat y/y.

But over time, as I gain investment experience, I’m increasingly alert and understanding of just how beneficial some revenue growth rate can be, however meager, for a business with a lot of debt to pay down – not just strong free cash flows, but growth too is necessary.

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Fairly Valued Already

Moving on, while I would not be opposed to going long this stock again if I found enough overarching evidence that Teva’s valuation was compelling enough to compensate investors, for now, I can’t build that argument.

Moreover, at $10 billion market cap for the world’s biggest generics pharmaceutical company, no rational-minded investor can possibly declare that Teva is exuberantly priced. Having said that, just because it’s not particularly expensive, it doesn’t automatically imply that the stock affords investors a sufficiently large margin of safety.

While on the one hand, Teva certainly does trade cheaply, as it trades for just 5x free cash flow. And that is cheap both relative to its own historical valuation as well as relative to the market as a whole.

As a brief aside, even though Mallinckrodt (MNK) was an easier call to argue that it was overvalued, its share price has remained volatile, and for a while, Mallinckrodt appeared to be a very attractive investment. Only in hindsight did its true colors present themselves.

Hopefully, Teva will be a rewarding investment, but for those investors more concerned with a loss of capital, rather than taking speculative punts, Teva is just too difficult to call.

Bottom Line

I believe that Teva share price over the coming year will struggle to reprice substantially higher to compensate investors for investing here.

Investing is difficult at the best of times, but when looking at Teva, investors have to contend with a business without stable revenue growth, saddled with too much debt, not to mention upcoming and uncertain lawsuits, as well as operating in a highly competitive environment – all taken together make this stock most likely fairly priced already.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



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