Even Juggernauts Have Bad Years

10/21/2011 9:16 am EST


Taesik Yoon

Editor, Forbes Investor and Forbes Special Situation Survey

But there's no doubt that the graying of the Baby Boomers makes healthcare one of the biggest potential growth industries in the Western world...and savvy drugmakers like this king of generics are primed to profit, writes Taesik Yoon of Forbes Growth Investor.

Teva Pharmaceutical Industries Ltd. (TEVA) is the world’s largest generic pharmaceutical company, producing generic alternatives to branded products covering all major treatment categories.

It also has a growing branded pharmaceutical business, which includes Copaxone for treating multiple sclerosis, Azilect for Parkinson’s disease, and products used to treat respiratory conditions and women’s health issues.

While the drug industry holds up better than most during market declines, due to the less-cyclical demand for pharmaceuticals, this has not been the case with Teva. The stock is down 34% since peaking above $57 per share back in February, and is currently trading at its lowest level in more than four years.

Part of the weakness likely stems from the pending $6.8 billion acquisition of Cephalon, a biopharmaceutical firm that develops branded medicines for central nervous system disorders, pain, cancer, and inflammatory disease. Its products include Provigil/Nuvigil, for treating sleep disorders, and Treanda, which is used to treat chronic lymphocytic leukemia and non-Hodgkin’s lymphoma.

After the acquisition announcement in early May, Cephalon reported disappointing second-quarter results, with revenue of $738.3 million and adjusted earnings of $1.62 per share. This fell well short of the $764.4 million in revenue and $2.06 per share estimated, due to lower-than-expected sales of its CNS drugs and a sharp increase in research and development costs.

More recently, Cephalon received subpoenas from the Department of Justice related to the marketing practices associated with Provigil/Nuvigil, as well as from the US Attorney in New York pertaining to Treanda.

Another concern is the slowdown in the TEVA’s own growth. Through the first six months of 2011, net sales and adjusted earnings were up 11.3% and 7.5%, respectively, from the same period in 2010, to $8.29 billion and $2.14 per share.

This was a far cry from the strong growth enjoyed over the past five years. From 2005 to 2010, net sales more than tripled to $16.12 billion, while adjusted earnings surged 186% to $4.54 per share.

Earnings growth is expected to return to a double-digit pace by the fourth quarter and also 2012. However, this is largely dependent on contributions from the Cephalon acquisition, which should be completed by year-end.

Given Cephalon’s weaker-than-expected recent operating results, the earnings accretion could prove less than expected. Nevertheless, the magnitude of TEVA’s share price decline seems excessive even in light of Cephalon’s woes.

The company has a strong acquisition history, which has been a key avenue of growth. This one expands TEVA’s branded product portfolio and increases its presence in international markets, including Switzerland and Latin America.

It also provides access to Cephalon’s rich product pipeline, consisting of approximately 30 compounds in late-stage development within the fields of CNS, oncology, respiratory and pain management. Additionally, while it may take slightly longer than projected, we believe TEVA will realize the $500 million in annual cost synergies that the acquisition is expected to generate.

At the same time, TEVA’s core generic drug operations should continue benefiting from two favorable trends:

  • Increased overall demand for pharmaceutical products, stemming from the aging of the population in its key markets, such as the US and Japan;

  • Greater promotion and usage of generic alternatives arising from efforts by public and private healthcare providers to keep costs down.

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