Does Teva's Terrible Tumble Make Its Stock a Buy?

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Disappointing financial results, a dividend cut, and reduced guidance have caused Teva Pharmaceutical Industries (NYSE: TEVA) shares to lose half their value in the past month. Can a restructuring help management reduce debt and kick-start shares, or is this company's share price on its way to zero?

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In this clip from the Motley Fool's Industry Focus: Healthcare podcast, analyst Kristine Harjes and contributor Todd Campbell explain why Teva Pharmaceutical's share price is tumbling and if investors should be bargain hunting or avoiding this company's stock.

A full transcript follows the video.

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This video was recorded on Sept. 6, 2017.

Todd Campbell: I feel like we've seen this movie before, Kristine.

Kristine Harjes: With Teva?

Campbell: Yeah. A company goes out, spends a lot of money on acquisitions, gets heavily indebted, sales start to fall, next thing you know, dot, dot, dot ...

Harjes: Yeah, here we are. Teva has a lot going on right now, but we will unpack all of that. As a reminder, back in August 2016, Teva bough Actavis, which is Allergan's generic business. This was largely funded by debt. Now, fast-forward a little bit to today, and that's gotten them in some trouble.

Campbell: Yeah, a little bit. The timing of it -- it looked like a really good deal at the time. It was a $40 billion deal, with some of it being done in Teva stock, and the rest of it being done in, quote-unquote, "cash." They borrow the money because, "Why not, the interest rates are low, I can go out and buy this money and finance it with the sales growth and the cash flow." That thinking is wonderful as long as you don't stumble and cash flow doesn't start to decline.

Harjes: Yeah. When Teva reported earnings on Aug. 23, its stock dropped 24% right away, which was due to a confluence of negative news in the earnings report. The most relevant one to this generics business was them saying that because of customer consolidation and increased competition from other generic-drug makers, they're just not getting the prices that they're used to. Apparently, the negotiations that they went through on their contract renewals led to a 6% overall price decrease. They expect that to continue eroding through the rest of the year. So that's alarming on its own, but I'm also really worried by the fact that management didn't really seem to see this coming.

Campbell: No. I don't think a lot of the industry did, to be fair. I think some of the pharmacies themselves have been surprised by the impact of falling generic pricing. I think you've seen it throughout the entire supply chain. The reality is this is the situation we're in today on Sept. 6. We have a company that's a mammoth, it's a Goliath in generic drugs, that now has this rope around its neck in the form of this big debt payment that it has to make. That's going to force it to make some pretty drastic decisions. They've decided to cut their dividend substantially.

Harjes: 75%, yeah.

Campbell: Yeah, which is something that income investors never want to hear. You can almost hear the shares being flushed out of income portfolios on that news. And they have all sorts of other problems right now with the share price, because Allergan, as part of that deal, got a whole bunch of shares in Teva. They don't want those shares, so they're planning on unloading them in the open market, selling them. So you have that weight on the share price as well. So you have a pitch situation where you have generic-drug price compression hurting margins and crimping cash flow, interest expense rising because of all of this debt, and a lot of shares becoming available for sale that's affecting the supply and demand for the pricing of the individual shares. Throw on top of all that, Kristine --

Harjes: Yeah, we're not done yet. If you had asked me a year ago, "What is Teva's largest problem?" I would have said the fact that Copaxone, which is a huge part of their branded business -- we talked about Teva as a generics business, but it actually does have a branded segment as well that is dominated by this one multiple sclerosis drug, it's the most popular MS drug in the world, and it's going to come off patent as early as next year. It could be facing unbranded competition, dragging down its profits from this drug. So we've had our eye on that forever. And all of a sudden, that problem is just one of many.

Campbell: Right, they went from 20 mg to 40 mg so they could improve the dosing schedule, that protected market share for a couple of years. Now, there's been ongoing patent disputes between them and some generics that have some people thinking that you could end up with a 40 mg competitor in relatively short order. This is a billion dollar-a-quarter drug. At one point, it was racking up $4 billion in sales. And in the second quarter, sales were down, I think, 12% in the United States to $843 million. This is a significant potential headwind at a time where the company doesn't need any more significant potential headwinds.

Harjes: Yeah. I'll also know that they are still looking for a permanent CEO. The guy that they have right now is not anything other than an interim president and CEO after the old CEO stepped down last February.

Todd, to wrap up this segment, when you're looking at this company, it has gotten really cheap if you look at it on an earnings multiple basis. Do you think it could be a value player right now?

Campbell: A value player or a falling knife, take your pick. I don't know. Whenever you look at these metrics, they're either trailing-12-month metrics, which really don't reflect the situation that Teva's moving into, or they're based on forward estimates, which could very well not pan out depending on how this business ends up performing over the next few quarters. It's very hard to say it's cheap at 3 times earnings per share if those are earnings per share could end up getting revised 50% lower. So we just simply don't know. You're right, it's trading at a price-to-book value that's less than 1. It's trading at a low single-digit P/E ratio. But the current ratio is also less than 1, which means it doesn't have a whole heck of a lot of wiggle room in the short term when it comes to financing its short-term or paying its short-term obligations.

Do I think that Teva Pharmaceuticals is going to disappear? I guess, push come to shove, no. Am I willing to bet more than 1% of my portfolio on it? [laughs] I think that's the way you have to look at it. You have to say, "Maybe this is cheap, and I think it's going to come out on the other side. And certainly, there are big demographic trends that support generic prescription volume over time. Maybe I'll put 1% of my portfolio in it, and if it ends up tripling or quadrupling from these levels over a course of five or 10 years, yay, I'm rewarded."

Harjes: Yeah. You also have that dividend yield that, at this point, is looking kind of insane. I want to say it's somewhere around 7%. But I agree with the hesitation in your voice that says this one is likely to be a falling knife.

Campbell: Yeah. Kristine. That dividend yield, though, is based on the trailing, not the forward, I don't think. And now that they've cut the dividend, I don't think it's yielding nearly as much. I don't think it's nearly as attractive on that. Over time, you could get into a situation where cash flow stabilizes, they have a plan to restructure by selling some units, raising some cash. If they can do those kind of things, and cash flow grows again, maybe the dividend starts increasing, and that will be one of the key drivers that makes the stock go much higher. But it's a very high risk-reward stock, in my opinion.

Kristine Harjes has no position in any of the stocks mentioned. Todd Campbell has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.