On Thursday, Teva (TEVA) reported in-line second-quarter results. For followers of the Best Ideas portfolio, the firm had a rough start shortly after it was added to the portfolio, but recent performance has put holders well into the black. For those interested in the background on the investment thesis on shares of Teva, please have a read of ‘Teva Pharma: Underpriced and Misunderstood.’
Teva’s revenue during the second-quarter nudged 3% higher, while non-GAAP operating income jumped 8%. Non-GAAP diluted earnings per share of $1.23 came in 3% higher than the same period a year ago. The company delivered organic growth in revenue and all profit lines over the comparable quarter last year. Though the results were solid, the thesis on Teva centers on expectations that Capoxone expiration won’t permanently reset the company’s profitability lower. We think the Street has largely written off the firm’s specialty pharma portfolio, despite ongoing progress within its pipeline and tremendous efforts to maintain the Capaxone franchise. Capaxone sales declined only 12% in the quarter, which we attribute primarily to customers reducing inventory in anticipation of a competing generic launch, which is not guaranteed to hit market.
Consistent with the thesis, the company’s generic business showed significantly improved profitability. US generic revenues advanced 10% from the same period a year ago thanks to a full quarter of sales of the generic equivalents of Xeloda and Lovaza—launched exclusively and first-to-market, respectively. The generic equivalents of Evista and Detrol also helped revenue in the US. Though European generic revenues declined modestly, rest-of-world (ROW) generic sales advanced 11% on a local-currency basis thanks to strength in Canada and Latin America. Profitability of the firm’s generic medicine segment amounted to $532 million in the quarter, compared to $376 million in last year’s period. Generic medicine profitability as a percentage of generic medicine revenues came in at 21%+ in the second quarter, up from 15.6%. Generic medicines will continue to represent a key growth component as governments around the world pursue lower-cost options for healthcare.
Cash flow from operations amounted to $1.1 billion, compared to ~$900 million in the same period last year. Free cash flow leapt to $583 million from $205 million in the second quarter of 2013. Cash and marketable securities came in at $1.2 billion. Cash flow generation and balance sheet health remain sound.
Valuentum’s Take
We identified an asymmetrical risk-reward opportunity in Teva’s shares when it was added to the Best Ideas portfolio July 24, 2013 at $41.22 per share – it is up 30% from those levels. The market has started to come around to factoring in a greater likelihood of the firm retaining a meaningful portion of the Capaxone franchise as well as stronger generic-medicine growth rates over the long haul.
Though Actavis (ACT) has scooped up Forest Labs (FRX) and Abbott (ABT) has been busy with Mylan (MYL), we continue to expect Teva to become either a target or a beneficiary from a merger-of-equals scenario. The only thing holding back a suitor, in our view, is the uncertainty regarding Capaxone, a level of uncertainty in this case that we view as a distinct positive. We maintain our view that an opportunity still exists in Teva’s shares.