Teva: A Favored Pharma
Teva Pharmaceutical Industries (TEVA; recent price $43.56) has what we believe to be the broadest product line and most extensive generic drug pipeline in the U.S., as well as a leading generic lineup in other countries. We believe Teva's ability to offer "one-stop shopping" for a wide variety of generic drugs has enabled many of its products to garner leading market shares.
According to IMS Health, a market research firm, Teva was the largest pharmaceutical company in the U.S. in 2006 on a total prescription basis, commanding an 11.4% share of all branded and generic drug prescriptions filled. Its manufacturing facilities in several countries provide Teva with a broad array of production technologies and economies of scale. Additionally, we believe that its active pharmaceutical ingredient (API) business, which continues to expand, offers stability of supply and vertical integration efficiencies. This permits Teva to be one of the lowest-cost producers, a position we view as another competitive strength.
Our 12-month target price is $51, representing potential price appreciation of about 17%. We view TEVA's valuation as compelling and our recommendation is 5 STARS (strong buy).
Generic Pharmaceuticals Business:
In 2006, Teva launched 30 new products in the U.S. and by yearend was selling 315 generics representing approximately 1,079 dosage strengths and packaging sizes. The number of prescriptions filled using Teva products was 416 million, representing 18.4% of total generic prescriptions, up from 358 million in 2005, partly on the acquisition of IVAX in early 2006.
As of June 30, 2007, Teva had 153 Abbreviated New Drug Applications filed with the Food and Drug Administration, representing more than $89 billion annually in brand value. Teva believes that 40 filings, with a brand value of more than $37 billion, have first-to-file status, which permits marketing exclusivity for the first 180 days.
In Western Europe, as of Dec. 31, 2006, Teva had 1,800 marketing authorization applications pending approval, corresponding to 140 compounds in 295 formulations. As of June 30, 2007, it had 134 compounds representing 280 formulations in that region. In addition, the acquisitions of IVAX and Sicor (2004) provided Teva with an expanded presence in Central and Eastern Europe (CEE), while IVAX also gave Teva an expanded footprint in Latin America.
Teva recently submitted its first biogenerics filing with the European Medicines Agency and the first biogenerics filing in Switzerland. We believe that the company has the technology and manufacturing capacity to be a major player in generic equivalents of biotech drugs. We lack visibility as to how large a market in such drugs Teva will be able to command once it launches its biogenerics in Western Europe and, eventually, we believe, the U.S. Nonetheless, we expect demand for its biogenerics to be sizable owing to our view of the high cost of biotech drugs.
Branded Pharmaceuticals Business:
Teva's presence in the branded drug market, although limited, helps expand and further diversify its overall drug catalog, while also aiding gross margins, in our view. Copaxone for multiple sclerosis (MS), Teva's first proprietary drug, became the market leader in the U.S. in 2005's first quarter and remained so into the second quarter of 2007, according to IMS Health data. Copaxone's global in-market sales grew 26% in 2005, 20% in 2006, and 23% in the first half of 2007. Going forward, we expect gains to decelerate, albeit unevenly, due to growth off of an expanding base (in terms of both dollars and MS patients).
Once-daily Azilect, Teva's proprietary drug for Parkinson's disease, was launched in Israel in March, 2005, in Europe in the second quarter of 2005, and in the U.S. in July, 2006. Azilect's revenues in the first half of 2007 were $53 million, compared to $44 million for all of 2006. Our earnings model assumes rapid growth of Azilect over the next few years.
Through its acquisition of IVAX, Teva gained a substantial presence in the U.S. and European markets for inhaled respiratory drugs, primarily for asthma and chronic obstructive pulmonary disease. Its products include CFC-free metered dose and dry powder inhalers, and certain other patented breath-activated inhaler devices. Respiratory product revenue was $374 million in the first half of 2007, reflecting growth in excess of 80% over first-half 2006 levels.
Teva also has clinical trials under way for an oral MS treatment and for drugs that treat lupus, ALS, Alzheimer's disease, and cancer. We do not expect to see commercialization of these treatments until the end of the decade.
We see the sales of the company's branded pharmaceuticals, bolstered by the intensified sales efforts behind respiratory products, growing faster than generic pharmaceuticals. Even so, we expect the branded business to remain a very small proportion of Teva's overall business.
Active Pharmaceutical Ingredients:
In our view, Teva's position as one of the largest suppliers of active pharmaceutical ingredients provides it with the competitive advantage of being vertically integrated. The company is less dependent on outside sources than most, if not all, of its generic drugmaker peers, which helps set Teva's cost of production lower. As of Dec. 31, 2006, Teva had in excess of 250 products in its API portfolio, compared to 108 at yearend 2003. Looking ahead, we expect Teva to launch 20 to 30 new APIs per year.
We estimate that external sales of API products will produce a compounded annual growth rate of 5% to 10% over the next three years, since we see Teva requiring well over half of its production capacity for internal growth. Despite this expected slow growth level, we believe external sales of API products result in gross margins above the company average and, hence, should exert a positive impact on Teva's overall gross margin.
We project revenues to rise 13.3% to $10.7 billion in 2008, from our 2007 revenue estimate of $9.5 billion, which reflects a 12.5% increase from 2006. We assume Teva will further benefit from the continued growth in global demand for generic drugs. The company looks to launch 70 to 80 products in 2007 to 2008, representing up to $35 billion in branded value in the U.S. Teva also projects that it will launch 30 to 40 generic products in 2007—as of June 30, 2007, it had launched 19.
We expect a deceleration in Teva's U.S. generic sales growth rate in 2007. The company has been benefiting this year from the exclusive launch of generic Lotrel for hypertension ($1.3 billion in annual brand sales), which occurred earlier than anticipated, and from the generic Oxycontin pain reliever, particularly as several rivals exited the market. While Teva might shortly benefit from the exclusive launch of generic Protonix for acid reflux ($2.5 billion), our model currently excludes this drug. Despite these "blockbuster" and other generic launches, we expect the aggregate 2007 brand value to still be below 2006's, when Teva benefited from 180-day exclusive launches of generic versions of Zocor anti-cholesterol ($4.4 billion), Zoloft antidepressant ($3.1 billion), Wellbutrin XL antidepressant ($1 billion), and Pravachol anti-cholesterol ($1.5 billion); the launches of several other drugs; and the February, 2006 acquisition of IVAX.
For 2008, we expect Teva to have 180 days of marketing exclusivity on some drugs, particularly generic Fosamax for osteoporosis ($1.9 million), generic Lamictal ($1.9 billion) anti-psychotic, and generic Wellbutrin XL ($900 million) for depression. All told, we believe that the aggregate brand value of generic drugs launched in the U.S. in 2008 will be above that of 2007's rollouts. Factors that may impact future launches include patent-protection litigation by branded drugmakers and the timing of FDA approvals.
Teva views price erosion as stable in its U.S. generic base business, with erosion rates comparable to those in the most recent quarters at just below 10% on an annualized basis. We expect price erosion to continue at this level for the next few years.
Our model assumes that Teva will begin to sell biogenerics in Western Europe in 2008 and that the number of biogenerics it will offer in the region will increase over time. While Teva sells hGH (human growth hormone) as a branded product in the U.S., pursuant to an agreement with Savient Pharmaceuticals (SVNT), we do not see it selling additional biopharmaceutical products as generics in the U.S. until 2010, by which time we expect a regulatory pathway for biogenerics to be in place.
On the branded pharmaceutical front, we see Teva benefiting from continued strong sales of Copaxone, Azilect, and respiratory products. In North America, Copaxone is currently marketed by Teva and distributed by Sanofi-Aventis (SNY). Teva indicates that it will assume full responsibility for the distribution of Copaxone in the U.S. and Canada commencing April 1, 2008, and will then record the full in-market sales of Copaxone, net of a royalty payment to Sanofi-Aventis of 25% of the in-market sales for two years. We assume only a modest profit contribution from the planned U.S. and Canadian rights buyback of Copaxone, due to Teva's full assumption of certain marketing expenses that Sanofi-Aventis shared.
For 2008, we see Teva's revenues growing in the mid-teens in Western Europe (including Hungary) and in its international segment (comprising the CEE, Latin America, and Asia), as the company introduces new generic and specialty drugs and continues to penetrate these regions.
We expect the company's gross margin to decline, albeit gradually, as the impact of intensifying competition in the generics market is mostly offset as Teva benefits from its vertical integration, improving economies of scale, the continued rise of specialty drugs in the sales mix, and assuming the launch of biogenerics in Western Europe. We also believe that Teva will gain the full value of the $200 million in cost savings it expects from the integration of IVAX, as well as the absence of costs undertaken to realize these synergies, in 2008. All told, we think the benefits will compensate for most of the price erosion we see on generic drugs without 180-day market exclusivity and for price controls outside the U.S.
We see a modest rise in research and development spending as a percent of revenues, due to Teva's increasing focus on specialty and biogeneric drugs, while the selling, general, and administrative expenses cost ratio should decline on well-controlled general and administrative expenses and on revenue leverage. All told, our 2007 operating earnings estimate is $2.30 per ADR, matching 2006's $2.30, and we look for $2.70 in 2008.
Our earnings model does not assume future acquisitions. However, we think that Teva has the financial flexibility to make additional acquisitions with cash and short-term investments of $2.7 billion and $936 million in operating cash flow in 2007's first half.
We remain encouraged about the long-term prospects for the overall generic drug industry, owing to aging populations in the U.S. and worldwide, health-care cost-containment efforts, the Medicare drug benefit in the U.S., and an increasing number and variety of drugs available in generic form. Frost & Sullivan, a market research firm, sees more than $100 billion worth of blockbuster drugs going off patent between 2006 and 2013. We believe the total value of drugs going off patent is significantly higher, reflecting the many nonblockbuster drugs that are also slated to go off patent during this time period.
The stock recently traded at 16 times our 2008 EPS estimate of $2.70 a share. Our projected three-year EPS growth rate of 16% for Teva starting in 2008 is above the 14% estimated peer average growth rate and we think Teva's size and diversity permit more stable and better-assured earnings growth than peers. For these reasons, we believe Teva's P/E-to-growth ratio deserves to be higher than its peers' 1.1 times. By setting its 2008 PEG ratio to an above-peer-average 1.2 times, we derive a 2008 P/E of about 19 times and, hence, our 12-month target price of $51.
Our discounted-cash-flow model derives an intrinsic value of about $51 per ADR.
We view positively that the board is comprised of 15 directors; the current chief executive is not a board member; a large majority of directors, 11 (73%), are independent, according to Nasdaq regulations; the board meets frequently; and that insiders do not sit on the audit and compensation committees. We view negatively that there is no disclosure of a policy that the board reviews its own performance regularly, and that there is no governance committee.
Risks to our recommendation and target price include FDA and foreign agency approval risk and the timing of the approvals, competitive and foreign regulatory pricing risk, and currency exchange rate risk. The company also has legal risks, most of which involve patent litigation, with Teva challenging the patents of the brand name owner or the brand name owner challenging Teva's right to make a generic equivalent of the brand name drug in question. Teva has significant operations in Israel, which may be adversely affected by terrorism or major hostilities.