What happened
Shares of Teva Pharmaceutical Industries (TEVA 2.41%), an Israeli-based developer of branded and generic drugs, imploded in August and lost 51% of its market cap, according to data from S&P Global Market Intelligence. While a perfect storm of issues influenced Teva's terrible month, most of the blame can be pointed at the company's second-quarter earnings release.
So what
For the quarter, Teva wound up reporting $5.69 billion in sales, which was notably higher than $5.04 billion reported in the year-ago period. However, the growth in sales came predominantly from its acquisition of Actavis, making it the largest producer of generic drugs in the world. In terms of adjusted profit, Teva's $1.02 in EPS fell short of Wall Street's expectations, and it was a sizable tumble from the $1.25 in adjusted EPS reported in Q2 2016. Further, the company lowered its full-year sales forecast by more than $1 billion at the midpoint, and it slashed its full-year EPS forecast to a range of $4.30 to $4.50, from a range of $4.90 to $5.30.
Image source: Getty Images.
There was a lot to digest in Teva's Q2 report, but the primary issue is that generic drugs are under intense competitive pressure, which is weighing on the margins and pricing power of generic drugmakers. It's unlikely that pricing power will stabilize for generic-drug companies for at least the next couple of quarters, meaning the company could continue to see margin and price erosion from its largest operating segment.
Another big issue for Teva is that blockbuster multiple sclerosis injection Copaxone is set to face generic competition very soon. Copaxone provides Teva with a very healthy profit margin, and sale erosion to generic competitors is going to sting its top- and bottom-line results.
And then there's its debt situation. Teva ended the latest quarter with more than $35 billion in debt, mainly as a result of the debt incurred from the Actavis acquisition. Management admitted that this debt is restricting the company's ability to be financially flexible and successful, so it's looking to jettison some of its non-core assets, including its women's health division and European oncology and pain segments.
Lastly, Teva announced that it would be slashing its dividend by 75% to $0.085 per quarter. As one of the top income stocks in the industry, this didn't sit well with investors.
Needless to say, Wall Street piled on the downgrades, money managers fled from the stock, and investors joined in the exodus.
Image source: Getty Images.
Now what
Without mincing words, Teva has a long road ahead. The company will need to prove to investors that it can successfully chip away at its $35 billion in debt. If the company can stand by its word to divest non-core assets and use free cash flow to eliminate $5 billion in debt by the end of the year, it'll probably go a long way toward restoring shareholder trust.
However, Teva is also going to need to see stabilization in generic-drug prices before it has any shot of heading higher. In this instance, I do believe the numbers are on Teva's side. Generic-drug makers typically rely on growing demand and higher volume to push sales and profits higher, and between 2015 and 2050, according to the U.S. Census Bureau, the elderly population in the U.S. is set to nearly double from 48 million to 88 million. Elderly folks are far more likely to take prescription medicines than younger adults, creating an ever-growing patient pool for Teva.
A third issue it'll need to resolve is hiring a well-respected CEO after losing both its CEO and CFO following a bribery scandal this past December. Essentially, the company needs a clean slate, but that's going to take time.
In the meantime, Teva's shares are valued at just four times its forward earnings, which is exceptionally inexpensive and signifies the long road that lies ahead. As a shareholder, I do believe the company is positioned to succeed in the long term, but I admit this is one heck of a speed bump in the road in the interim.
