The Israeli generic drug giant Teva Pharmaceuticals (TEVA 1.85%) isn't exactly an obvious investment suggestion. Over the last five years, its shares are down by more than 66%, while the broader S&P 500 index's total return has been around 105%. Trouble for Teva: it's barely profitable, its base of revenue may be shrinking, and it could continue to lose ground.
On the other hand, if Teva manages to make a comeback in spite of clear headwinds, it'll bring wealth to the contrarian investors who saw its potential. Let's dig into this generic pharmaceutical company and evaluate its merit as a contrarian choice for investors with an appetite for risky picks.
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Why you'd need to be a contrarian to invest in Teva
Many investors might shy away from Teva Pharmaceuticals because the company has a lot of legal problems pertaining to its alleged role in the opioid crisis. So far, out-of-court settlements have left Teva on the hook for hundreds of millions of dollars in damages, which the company will be paying back for a very long time. Teva owes the state of Texas alone $150 million, plus $75 million worth of the anti-opioid nasal spray Narcan. That's just one state, and more are in line: Teva has already reached similar agreements with other entities and is still defending itself from opioid-related lawsuits in others.
Considering these numbers, the settlements are likely to be a significant drag on Teva's ability to invest in growth. In 2021, Teva had free cash flow (FCF) of $2.2 billion, and cash holdings of only $2.1 billion.
Beyond that massive problem, the company's financials spell out other large issues. Teva shareholders have been short on good news over the last five years, with sales, gross profits, FCF, and even total assets shrinking at a dramatic clip.
TEVA Revenue (Annual) data by YCharts
The decline in assets is particularly concerning, as the entire business model of a generic drug manufacturer like Teva depends heavily on continuing to build out new production lines that can yield many years of revenue. If the value of its assets is declining, it means that long-term growth prospects are wilting due to a lack of fresh investment in production.
On top of all that, the company has a debt load of $23.5 billion. At first glance, that looks quite unmanageable, given Teva's razor-thin profit margins and trailing 12-month revenue of only $15.8 billion.
Why the contrarians could be correct
As challenging as Teva's current position is, there is a reasonable, albeit contrarian, investment thesis at play here that could bring riches to the daring investor. The below chart illustrates the crux of that contrarian thinking.
TEVA Normalized Diluted EPS (Quarterly) data by YCharts
Within the last three years, Teva's quarterly normalized diluted earnings per share (EPS) tumbled sharply, but have since more than recovered. During that same period, the company made steady progress in paying off and refinancing its debt, with plans to continue retiring debt at largely the same rate.
Plus, its expenses as a fraction of quarterly revenue are dropping as a result of cost-cutting efforts and site consolidations that have been going on since at least 2017. More expense reductions will further widen Teva's profit margins. With greater profit margins, management will have more leeway to reinvest in developing new generics that could grow the business' top and bottom lines. Not to mention that heightened margins will allow Teva to pay off debt at an even faster rate.
Then there's Teva's product portfolio, which could soon include a biosimilar version of the best-selling psoriatic arthritis drug Humira -- if regulators give the product a green light. AbbVie, the original developer of Humira, made $20.7 billion from sales of the drug last year. When the large-molecule drug's patent expires in 2023, Teva (along with a handful of its peers) will have a shot at taking a significant slice of that massive pie.
Teva has been sorely lacking in long-term revenue growth for some time. Its Humira biosimilar might well provide it with some.
Is a turnaround likely?
I think that the contrarian narrative about Teva is largely correct, except when it comes to one critical piece: the potential for shareholder returns.
Generic drug manufacturers aren't growth stocks, and not even Teva's improvement trajectory can change that. Right now, Teva is a perennially underperforming company, not an undervalued or misunderstood gem.
There isn't any general expectation for rapid growth in Teva's revenue or earnings. The company also isn't exposed to any positive catalysts which could drive share price appreciation. At best, Teva could navigate its current problems well enough to fix them, and then transition into a business that returns capital to shareholders slowly over the long term. Yet it's impossible to imagine this stock beating the market under most conditions, even if the company undergoes a revitalization.
Of course, having said that, it's possible that I just don't see the true brilliance of the contrarian perspective on Teva Pharmaceuticals. But to be safe, I'd avoid buying this stock anyway.
