Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
This is not the way upgrades are supposed to work.
This morning should have been a great one for shareholders of Teva Pharmaceutical Industries (NYSE: TEVA). One a one-two punch of upgrade goodness, Teva won a pair of endorsements from two separate analysts. Yet instead of jumping on the news, Teva stock is more wobbling around a 0% gain today, up a little one minute, down a bit the next -- and actually down 0.2% as of 10:30 a.m. EDT.
So what's up with that? Let's find out.
We'll start with the milder of today's two reports. Citing "improving business fundamentals as well as the improving multiples for the overall generics sector," analysts at Leerink Partners this morning upgraded Teva shares to market perform.
Despite new competition from two rival generics, Leerink notes that Teva "has defended the Copaxone franchise" -- Teva's branded drug for the treatment of multiple sclerosis that once provided as much as 20% of the company's revenue. Leerink estimates that Copaxone retains 85% market share "despite two generic entrants." (Mylan's competing generic version of Copaxone appears to be gobbling up much of Teva's lost market share.)
Leerink is also pleased to see that Teva is progressing with its cost-cutting efforts, and estimates the company will be able to pay off as much as $3.5 billion of its debt by the end of this year. Regardless, after revising upwards its price target on Teva shares, to $24, Leerink appears to have decided that there's not enough upside from the stock's current $21ish share price to justify a buy rating.
Upgrading Teva -- with enthusiasm
Paying down debt is "key to the TEVA story," argues Goldman, and Teva "has barely missed a beat" in its efforts to cut costs and pay down debt since its cost-cutting plan was announced late last year -- in fact, it's ahead of schedule. Teva is also on track to resuming revenue growth in 2020, argues the analyst, and this justifies a much richer price target of $30 a share.
If Goldman Sachs us right about that, investors in Teva today stand to earn as much as a 39% profit on the stock over the course of the next year.
Valuing Teva Pharmaceutical stock
Could that be possible? I mean, Teva stock has more or less tracked the S&P 500's performance over the past year, beating the index by a percentage point or two. But could it really race ahead nearly 40% over the next 12 months?
Here's how I look at it.
Currently, Teva is unprofitable, with $10 billion in reported GAAP losses over the past 12 months. That doesn't worry me, however, because Teva's cash flow statement shows that the company in fact generated a whopping $3.8 billion in positive free cash flow (FCF) even as it was reporting these losses.
Even focusing on Teva's trailing-six-month performance, with only $1.4 billion in FCF produced, and run-rating that number out to a full 12 months ($2.8 billion in FCF), I get a valuation of less than eight times FCF on Teva stock at its current $21.9 billion market capitalization. If Goldman is right, and Teva is set to resume growing less than two years from now, it shouldn't be too hard for the company to put up growth numbers sufficient to justify that valuation...except for one thing:
The big ding on Teva stock right now isn't so much the company's market cap, which is actually quite modest. It's the company's debt, which is much bigger at $30.2 billion ($28.4 billion net of cash on hand). Added to the company's market cap, debt gives Teva an enterprise value of $50.3 billion, and an EV/FCF ratio of 18 -- a much richer valuation that will require much more impressive growth to justify.
The upshot for Teva investors
Thus the question for me isn't really, "Can Teva resume single-digit growth rates two years from now?" but rather, "Can Teva grow in the strong double digits?"
Given that most analysts polled by S&P Global Market Intelligence don't expect Teva to grow revenue at all between this year and 2022, I'd say that Goldman is in the minority view on this debate right now. But the more progress the company makes toward paying down its debt (and consequently, lowering its enterprise value), the less growth it should take to make the case for Teva.
Bottom line: Watch that balance sheet. Like Goldman says, it's the "key to the TEVA story."
10 stocks we like better than Teva Pharmaceutical IndustriesWhen investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has quadrupled the market.*
David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Teva Pharmaceutical Industries wasn't one of them! That's right -- they think these 10 stocks are even better buys.
Click here to learn about these picks!
*Stock Advisor returns as of August 6, 2018