Teva: A Favored Pharma

Standard & Poor's likes the generic drugmaker's strong pipeline and global presence, and rates the shares a strong buy

by Phillip Seligman From Standard & Poor's Equity Research

Teva Pharmaceutical Industries (TEVA; recent price $43.56) has what we believe to be the broadest product line and most extensive generic drug pipeline in the U.S., as well as a leading generic lineup in other countries. We believe Teva's ability to offer "one-stop shopping" for a wide variety of generic drugs has enabled many of its products to garner leading market shares.

According to IMS Health, a market research firm, Teva was the largest pharmaceutical company in the U.S. in 2006 on a total prescription basis, commanding an 11.4% share of all branded and generic drug prescriptions filled. Its manufacturing facilities in several countries provide Teva with a broad array of production technologies and economies of scale. Additionally, we believe that its active pharmaceutical ingredient (API) business, which continues to expand, offers stability of supply and vertical integration efficiencies. This permits Teva to be one of the lowest-cost producers, a position we view as another competitive strength.

Our 12-month target price is $51, representing potential price appreciation of about 17%. We view TEVA's valuation as compelling and our recommendation is 5 STARS (strong buy).

Company Overview

Generic Pharmaceuticals Business:

In 2006, Teva launched 30 new products in the U.S. and by yearend was selling 315 generics representing approximately 1,079 dosage strengths and packaging sizes. The number of prescriptions filled using Teva products was 416 million, representing 18.4% of total generic prescriptions, up from 358 million in 2005, partly on the acquisition of IVAX in early 2006.

As of June 30, 2007, Teva had 153 Abbreviated New Drug Applications filed with the Food and Drug Administration, representing more than $89 billion annually in brand value. Teva believes that 40 filings, with a brand value of more than $37 billion, have first-to-file status, which permits marketing exclusivity for the first 180 days.

In Western Europe, as of Dec. 31, 2006, Teva had 1,800 marketing authorization applications pending approval, corresponding to 140 compounds in 295 formulations. As of June 30, 2007, it had 134 compounds representing 280 formulations in that region. In addition, the acquisitions of IVAX and Sicor (2004) provided Teva with an expanded presence in Central and Eastern Europe (CEE), while IVAX also gave Teva an expanded footprint in Latin America.

Teva recently submitted its first biogenerics filing with the European Medicines Agency and the first biogenerics filing in Switzerland. We believe that the company has the technology and manufacturing capacity to be a major player in generic equivalents of biotech drugs. We lack visibility as to how large a market in such drugs Teva will be able to command once it launches its biogenerics in Western Europe and, eventually, we believe, the U.S. Nonetheless, we expect demand for its biogenerics to be sizable owing to our view of the high cost of biotech drugs.

Branded Pharmaceuticals Business:

Teva's presence in the branded drug market, although limited, helps expand and further diversify its overall drug catalog, while also aiding gross margins, in our view. Copaxone for multiple sclerosis (MS), Teva's first proprietary drug, became the market leader in the U.S. in 2005's first quarter and remained so into the second quarter of 2007, according to IMS Health data. Copaxone's global in-market sales grew 26% in 2005, 20% in 2006, and 23% in the first half of 2007. Going forward, we expect gains to decelerate, albeit unevenly, due to growth off of an expanding base (in terms of both dollars and MS patients).

Once-daily Azilect, Teva's proprietary drug for Parkinson's disease, was launched in Israel in March, 2005, in Europe in the second quarter of 2005, and in the U.S. in July, 2006. Azilect's revenues in the first half of 2007 were $53 million, compared to $44 million for all of 2006. Our earnings model assumes rapid growth of Azilect over the next few years.

Through its acquisition of IVAX, Teva gained a substantial presence in the U.S. and European markets for inhaled respiratory drugs, primarily for asthma and chronic obstructive pulmonary disease. Its products include CFC-free metered dose and dry powder inhalers, and certain other patented breath-activated inhaler devices. Respiratory product revenue was $374 million in the first half of 2007, reflecting growth in excess of 80% over first-half 2006 levels.

Teva also has clinical trials under way for an oral MS treatment and for drugs that treat lupus, ALS, Alzheimer's disease, and cancer. We do not expect to see commercialization of these treatments until the end of the decade.

We see the sales of the company's branded pharmaceuticals, bolstered by the intensified sales efforts behind respiratory products, growing faster than generic pharmaceuticals. Even so, we expect the branded business to remain a very small proportion of Teva's overall business.

Active Pharmaceutical Ingredients:

In our view, Teva's position as one of the largest suppliers of active pharmaceutical ingredients provides it with the competitive advantage of being vertically integrated. The company is less dependent on outside sources than most, if not all, of its generic drugmaker peers, which helps set Teva's cost of production lower. As of Dec. 31, 2006, Teva had in excess of 250 products in its API portfolio, compared to 108 at yearend 2003. Looking ahead, we expect Teva to launch 20 to 30 new APIs per year.

We estimate that external sales of API products will produce a compounded annual growth rate of 5% to 10% over the next three years, since we see Teva requiring well over half of its production capacity for internal growth. Despite this expected slow growth level, we believe external sales of API products result in gross margins above the company average and, hence, should exert a positive impact on Teva's overall gross margin.

We project revenues to rise 13.3% to $10.7 billion in 2008, from our 2007 revenue estimate of $9.5 billion, which reflects a 12.5% increase from 2006. We assume Teva will further benefit from the continued growth in global demand for generic drugs. The company looks to launch 70 to 80 products in 2007 to 2008, representing up to $35 billion in branded value in the U.S. Teva also projects that it will launch 30 to 40 generic products in 2007—as of June 30, 2007, it had launched 19.