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Morningstar | Teva's 2Q Results Reflect Ongoing Copaxone and Generics Headwinds

We plan to modestly raise our fair value estimate for no-moat Teva, especially as Copaxone is holding up better than our initial expectations following generic competition, but we still think the current stock price reflects too much optimism about the company's turnaround efforts. Although management slightly increased its bottom line outlook for the year, Teva still faces a number of significant hurdles, including increasing price competition from Copaxone generics, an uncertain generics pricing environment in the U.S., and a large debt balance. Management roughly outlined an expectation for near $18 billion in revenue for 2019, which is relatively close to our forecast. While we don’t see much growth from the generics side of the business, we do anticipate some recovery in operations from Austedo and the potential upcoming launch of fremanezumab for chronic migraine later this year. That said, we think management’s longer-term adjusted operating margin target near 27% and an EBITDA leverage target of four times by 2020 look difficult. Teva's net debt balance was $28.4 billion by the end of the quarter.

This quarter’s 29% and 46% decline in North American generics and Copaxone sales, respectively, signify Teva's tough situation. Generic segment pricing pressure still looks challenging in the U.S. market, where additional competition on generic Concerta particularly affected Teva during the quarter. Part of Teva's generic segment weakness also stems from product discontinuations amid management's focus on profitability. This quarter's results don’t necessarily reflect management’s commentary that generic pricing in the U.S. has shown some stabilization. Although Copaxone sales were relatively stable from the first quarter, increased market share gains and more aggressive pricing from Mylan should dent sales in the back half of the year. Management currently anticipates roughly $2.1 billion in Copaxone sales for the year, which implies a 45% decline from 2017.

The hit to Copaxone and the U.S. generics businesses has similarly brought down adjusted gross margin to 50.4% from 57% last year, with cost-saving initiative offsetting some of the damage. Part of the gross margin pressure also stemmed from limited stocking of QVAR during the quarter as customers make the transition to the new RediHaler version of the product. Adjusted operating margin, which excludes nearly $700 million in Actavis and Rimsa related intangible and goodwill impairments during the quarter, was down 160 basis points from last year.