Why Is This Generic Manufacturer Being Trampled by Its Industry Rivals?

Many investors in the pharmaceutical industry have been paying close attention to the dreaded patent cliff that has drained the revenue of leading companies such as Pfizer, Merck, and Eli Lilly.

As their patents expire, generic manufacturers -- such as Teva Pharmaceutical (NYSE: TEVA  ) , Actavis (NYSE: ACT  ) , and Mylan (NASDAQ: MYL  ) -- swoop in to produce their cheaper versions of the drugs. However, the generics industry is a highly competitive, low-margin business. As a result, the disparity between these three companies is vast, and Teva has been crushed by Actavis and Mylan over the past five years.

TEVA Chart

Source: YCharts.

Why is Teva trailing its industry peers by such a wide margin? Let's take a closer look at the three companies to find out.

Let's meet the generic makers
Teva, Actavis, and Mylan all operate across most global regions. Teva is the largest of these companies by market capitalization, followed by Actavis and Mylan. All three companies generate the majority of their revenue through sales of generic drugs, but also sell specialty (branded) drugs as well. This is the reverse of pharma giant Novartis, which primarily sells specialty drugs but uses its generic arm, Sandoz, as a counterbalance.

A look at the fundamentals quickly reveals why Teva has been left in the dust over the past five years.

Company

5-Year PEG

Forward P/E

Return on equity

Quarterly Earnings Growth (YOY)

Quarterly Revenue Growth (YOY)

Teva

5.05

7.40

1.65%

(6.3%)

(1.4%)

Actavis

1.27

11.22

-15.84%

42%

46.8%

Mylan

1.46

11.57

21.5%

28.2%

0.8%

Advantage

Actavis

Actavis

Mylan

Mylan

Actavis

Source: Yahoo! Finance as of Oct. 9.

Teva might be considered the cheapest on a P/E basis, but its 5-year PEG ratio shows very low expectations for long-term growth. By comparison, Actavis and Mylan are still fairly healthy (closer to 1.0) based on their PEG valuations.

Teva has also posted negative top and bottom line growth while Actavis has been advancing both by double digits. Although Mylan's revenue growth is anemic, its earnings growth is still robust.

A comparison of the generics businesses
Teva's generic business, which is split across three global regions, accounts for 56% of its total revenue -- a much lower figure than Actavis or Mylan, which respectively rely on generics for 80% and 85% of their quarterly sales.

Last quarter was a disappointing one for Teva, which reported top line declines in all three regions of its generics business.

Company

Revenue from generics

Growth (YOY)

Percentage of total sales

Teva

$970 million (U.S.)

$860 million (Europe)

$945 million (Rest of world)

(8%)

(3%)

(8%)

20%

17%

19%

Actavis

$1.6 billion (global)

58%

80%

Mylan

$1.45 billion (global)

(1.4%)

85%

Sources: Company earnings reports (most recent quarter), author's calculations.

In the United States, Teva was hit by lower sales of generic Lexapro, an antidepressant, and Avapro, a high-blood pressure medication. Those losses were partially caused by Mylan, which launched its own generic Lexapro last year. Lexapro was once the top blockbuster drug for Forest Laboratories (NYSE: FRX  ) , which generated $13.8 billion in revenue for the company between 2002 and 2011.

Teva also reported no royalties on generic Lipitor for the quarter. However, the company reported higher sales of generic asthma medication Pulmicort and ADHD drug Adderall. Teva's European sales were dragged down by macroeconomic problems in Italy and Spain, although generic sales picked up slightly in France.

Actavis' big jump in revenue was primarily attributed to its acquisition of Actavis Group for $6.1 billion last year. Prior to the acquisition, the company was known as Watson Pharmaceuticals -- changing its name and listing to Actavis after the acquisition completed. The deal instantly made Actavis the third largest generics maker in the world. In addition, strong sales of generic Zovirax (herpes), Yaz (birth control), and Viagra (erectile dysfunction) helped the company post a whopping 209% year-over-year sales increase in international markets.

Meanwhile, Mylan reported 15% sales growth in Europe, the Middle East, and Africa, fueled by strong demand in India. However, sales in North America declined by 14%, offsetting those gains.

A comparison of the specialty businesses
Teva's heavier dependence on its specialty brands also didn't pay off this quarter.

Although its specialty business is much larger than Actavis and Mylan's, sales edged up 5% as gains in Copaxone (multiple sclerosis), Treanda (chronic lymphocytic leukemia), and ProAir (respiratory problems) were offset by losses in daytime wakefulness aids Provigil and Nuvigil, and Azilect (Parkinson's disease). Sales of Provigil notably plunged 60% year over year to $19 million due to generic competition.

Company

Specialty revenue

Growth (YOY)

Percentage of total revenue

Teva

$2.1 billion

5%

43%

Actavis

$144.8 million

21%

7%

Mylan

$236.9 million

15%

14%

Sources: Company earnings reports (most recent quarter), author's calculations.

Copaxone is Teva's biggest asset in its specialty portfolio, accounting for 52% of its specialty revenue and 22% of the company's total sales. Unfortunately, it is also about to become its biggest liability.

The major threat to Teva is Biogen Idec (NASDAQ: BIIB  ) , whose new multiple sclerosis treatment, Tecfidera, threatens to reduce Teva's MS market share dramatically. Tecfidera is an orally administered treatment, whereas Copaxone is injected. In addition to being more convenient, Tecfidera also has a milder side effect profile than Copaxone, which causes large, permanent depressions in the skin at the injection point in 45% of patients. To make matters worse, a U.S. court invalidated a 2015 patent for Copaxone in July, which means that generic competition could arrive by next year.

Between July and August, Copaxone's U.S. market share fell from 36.2% to 35.7%. Meanwhile, Tecfidera's market share rose from 9.3% to 11.8%. UBS analysts believe that this trend will continue, and Copaxone's share will fall to 25.4% by 2014, sealing the fate of Teva's top-selling drug.

Meanwhile, Actavis' strong growth in specialty brands came from leading products like Rapaflo (enlarged prostate), Crinone (menopause), Generess Fe (birth control), and Kadian (chronic pain). Mylan's specialty revenue was boosted by strong demand for its flagship product, the EpiPen auto-injector for severe allergic reactions.

In other words, neither Actavis nor Mylan needs a single product as much as Teva needs Copaxone.

The Foolish takeaway
There is a bitter irony in Teva's story -- although the company intended to profit from the patent losses of large pharmaceutical companies, it fell into the same trap. On the generic side, it suffered from lower sales of Lexapro, and on the specialty side, its top seller Copaxone is now besieged by a superior treatment and generic competitors.

Therefore, Teva has become a flipped mirror image of the pharmaceutical companies that it was seeking to copy -- a top-heavy company that is about to lose its top product. Meanwhile, Actavis and Mylan, with their more balanced drug portfolios, should keep stomping Teva into the ground.

Generics may be cheaper, but health care's still expensive
Rising health care costs continue to be a hotly debated topic, and even legendary investor Warren Buffett called this trend "the tapeworm that's eating at American competitiveness." To learn more about what’s happening to the health care system -- and how to potentially profit from this trend -- click here for free, immediate access.


Read/Post Comments (0) | Recommend This Article (0)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2674871, ~/Articles/ArticleHandler.aspx, 10/22/2014 4:10:54 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement