Teva (TEVA) reported Q3 revenue of $5.61 billion and eps of $1.00. The company missed on revenue by $10 million and missed on eps by $0.04. The stock sold off nearly 20%. Below are the reasons I think the stock sold off.
Managing Wall Street’s expectations is highly-important for a publicly-traded company. Analysts hate negative surprises. Teva surprised many analysts with negative guidance for Q4 and full-year 2017. The company guided that Q4 revenue could be $5.3 – $5.4 billion. The mid-point of that guidance ($5.35 billion) implies Q4 revenue could be off nearly 5% sequentially. Q3 actual revenue was up 1% Y/Y and down 1% Q/Q. Management gave full year revenue guidance of $22.2 – $22.3 billion. The mid-point of the range is down over 3% versus the previous guidance.
Heading into the quarter the loss of exclusivity for Copaxone was well known. The next step was to determine how much Mylan (MYL) would discount prices by, if Teva would match those prices and how much share Teva would lose. The guidance does reflect an earlier than expected launch of generic Copaxone. However, it also reflects delays in generic launches and price erosion in the Generics segment:
In addition, we have lower than expected contribution from new generic launches in the U.S. We now project approximately $400 million of revenues from new product launches this year, compared to a previous projection of $500 million.
In addition, we have increased price erosion and volume declines in our U.S. Generic business, including increased competition to our largest product, the Concerta authorized generic.
In my opinion, when certain products are launched could be a timing issue. Generics is Teva’s bread and butter and it will continue to generate a stream of income from new products. It loss of pricing power could be a headwind for a while, however. As the company’s main customers, drug stores for instance, get bigger and consolidate out-sized buying power they can use that power to negotiate better prices. The U.S., which represents over 35% of the Generics segment, experienced 10% price erosion and it might not abate any time soon.
Teva’s Q3 revenue was up 1% Y/Y. Revenue from Generics was off 8%, while Copaxone revenue fell 7%. Copaxone (included in MS Specialty) was negatively impacted by a $55 million increase in managed care rebate accruals following the approval of generic Copaxone. The stalwart of the quarter was the Specialty segment which experienced an increase of 6%; the growth was powered by its respiratory and oncology drugs, slightly offset by a loss of exclusivity for Azilect.
As revenue has fallen, so has the company’s margins. Gross margin was 47%, down from 50% in the year earlier period. EBITDA margin was 29%, down from 35% in the year earlier period. On a dollar basis EBITDA was $1.6 billion, down 16% Y/Y. Generics is the largest segment (59% of revenue), so its loss of pricing pressure likely had an out-sized impact on margins. Copaxone has the highest EBITDA margins (north of 80%) so its decline in also weighed on margins.
Teva cut R&D to and sales & marketing expenses as a percentage of revenue. I expect new CEO Kare Schultz to make deeper cuts over the coming quarters. However, as Copaxone revenue declines I expect margins to continue to erode.
Deteriorating Credit Metrics
While revenue and margins continue to decline Teva’s $35 billion debt load is a lot stickier. Teva recently divested its Paragard intrauterine copper contraceptive for over $1 billion, which should reduce debt further. As of Q3 Teva’s debt/run-rate EBITDA was around 5.3x. Moody’s would like to see the company reduce leverage to 4.0x long-term. With the company’s largest operating segment facing pricing pressure leverage could remain high for the foreseeable future. It could be a cause of concern as the company might have to take drastic measures – job cuts, dividend cut, capex reductions – to pare its debt load.
Trump And The Global Economy
We had our second installment of Trump And The Global Economy town hall in October. Professor Lance Brofman, Coconut Rob, Wuyi Jacobs (AfroBeats Radio) and Shock Exchange, author of Shock Exchange: How Inner-City Kids From Brooklyn Predicted the Great Recession and the Pain Ahead chopped it up with hundreds of members of the Brooklyn community. The town hall is designed to give the public real information about Trump’s policies on taxes, immigration, the economy, the stock market, etc. and how they will impact the country and the community.
You guessed it, drug makers like Valeant, Celgene, Mallinckrodt, Insys, Depomed, and Allergan were the topic. We explained everything from these companies’ price-gouging to tax avoidance to insolvency to contributing to the opioid epidemic.