Is Teva's Situation Really So Dire?

Is Teva's Situation Really So Dire?

The recent news on Teva Pharmaceutical Industries , the world's largest generic drug manufacturer, about its disappointing quarterly earnings report and the stepping down of its CEO, Dr. Jeremy Levin, has taken its toll on the company's stock. Teva's stock lost more than 11% last week. But is the company's situation so dire? To answer this question, let's take a look at Teva's outlook and compare its performance to its competitors such as Impax Laboratories . Let's start with its latest quarterly earnings report.

Third-quarter reports
Teva's third-quarter revenues slightly increased by 1.7% year-over-year; its operating profit was $801 million, which was much higher than its profit in the third quarter of 2012. Most of the company's legal and impairments provisions -- including a $930 million pantoprazole patent litigation provision -- were recorded in the preceding quarters. Part of the $930 million provision is related to the company's $1.6 billion settlement with Pfizer topay its subsidiary Wyeth. Teva has already paid $800 million up to September. Teva will make the rest of the payment in 2014. Therefore, most of the company's legal settlement fees were already paid for or set aside. Let's turn to the other hot issue that drove the company's stock down: the CEO's departure.

The layoffs and CEO
Teva announced a month ago that it will lay off 5,000 employees worldwide -- 10% of its workforce -- by the end of 2014. The restructuring is expected to save the company $300 million this year, according to Teva.

This cost cutting, however, is also supposedly among the reasons behind CEO Dr. Jeremy Levin's decision to exit the company. The market reaction may have been harsh especially, since Teva expects to save from its restructuring program $2 billion a year by 2017 and $1 billion by the end of 2014. If Teva's estimates are correct, then its operating profit -- after controlling for goodwill and other one-time provisions -- is likely to rise to more than $4 billion. Even if the CEO didn't agree with this course of action, Teva is still likely to improve its bottom line. Nonetheless, cost control isn't the main drawback the company faces. The lack of growth is the main concern. Let's start with Teva's generic segment.

Generic medicines sales remain stagnate
Teva's generic business remained nearly flat in the third quarter: Sales inched down by nearly 0.36% in the third quarter of 2013 compared to 2012. The drop in sales was mostly due to lower sales in Europe and Asia. Conversely, U.S sales grew by 6% in the past quarter. Have Teva's competitors done any better?

During the third quarter, competitor Impax Laboratoriesincreased its generic revenues by 15% because it launched new products such as trilipix. So Impax's sales have increased at a faster pace than Teva's.

Looking forward, Teva estimates that its generic sales will reach $10.50 billion in 2013. Based on the first three quarters of 2013, the company's annual net sales may reach only $9.6 billion, which is 8.5% lower than the company's outlook. Therefore, if generic sales don't pick up in the next quarter, the company won't meet its expectations. The generic segment is only half of Teva's operations; the other half is its specialty segment that poses the biggest threat on the company's outlook.

Specialty medicines revenues rallied
Teva's specialty medicines segment's net sales rose by 2.9% in the third quarter of 2013. The rise in sales was mostly related to higher sales in U.S and Europe.

Looking forward, the main concern is the loss of exclusivity on the copaxone (an MS treatment). The current patent expiration, unless U.S courts rule otherwise, for copaxone is set to arrive in May 2014. Copaxone sales account for more than half of Teva's brand segment and 21% of total sales. What will become of copaxone sales in the coming years? Let's examine a couple of examples for a market reaction to a loss of exclusivity.

Pfizer lost its Lipitor exclusivity back in November 2011. As a result, sales have dropped by 59% in 2012. In the first nine months of 2013, sales of the treatment fell by an additional 49%. Impax Laboratories lost its zomig tablet and ZMT products' exclusivity this past May. In the third quarter, sales of the brand division have declined by 62%.

Based on the above, assuming Teva's sales of the treatment decline in a similar rate as other brand treatments, then copaxone sales are likely to fall by 60% in the first year and another 50% in the second year. This means that copaxone sales are likely to fall by 13% in 2014 (with loss of exclusivity at the end of May) and by 56% in 2015. Next year, this would result in more than a $400 million drop in sales, which is less than 2% drop in total sales. So for the near future, the loss of exclusivity won't be so dire. Moreover, Teva is developing a copaxone treatment that will be administered orally three times a week instead of through daily injections. Currently, that treatment is in phase 3 clinical trials. This treatment could rally Teva's drop in sales due to loss of exclusivity of the copaxone.

The Foolish bottom line
Teva faces many challenges, but its situation isn't so dire. Despite the strong competition, the company's generic sales rose in the U.S. The loss of exclusivity of copaxone isn't news, but the potential rise in sales from the oral treatment could pull back up the company's sales in the near future. Finally, Teva's cost restructure program might not be popular due to its layoffs, but it's likely to increase the company's profit margin, which could result in a higher dividend.

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