U.S. Markets closed

Risk-Reward With Teva Pharmaceutical

- By Jonathan Poland

As two of its largest guru shareholders, John Paulson ( Trades , Portfolio ) and David Tepper ( Trades , Portfolio ) are dead wrong on Teva Pharmaceutical Industires Ltd. (TEVA). Teva is a value trap even if the stock had a short-term price pop. Paulson owns 15.9 million shares, good for 7.36% of his portfolio, while Tepper owns 5.05 million shares, good for 3.25% of his total assets managed.

Health care stocks (biotech specifically) have not seen a "Trump bump." Rather, they have experienced the opposite as more scrutiny comes to light over high drug prices and how the Trump administration intends to handle the problem.

Teva plans to cut as many as 6,000 jobs (11% of its workforce) and has dealt with costly acquisitions for the last year, along with delayed drug launches and increased competition. The resignation of CEO Erez Vigodman last month sent shares to a 10-year low of $32.61. It is hard to say at this point whether that will be a good thing or not.

Teva itself has been able to increase sales, but has been forced to increase its share count while operating margins have shrunk from 25.5% to 9.8%. More importantly, the company lacks competitive advantages. With the needed continuance to spend more and more on both research and development and selling, general and administrative costs, the stock will likely fluctuate over the next decade as well.

In August , Allergan (AGN) will be able to sell 100 million Teva shares, which it acquired when it sold Actavis Generics to Teva. This is significant because it represents roughly 10% of the float and has the ability to create significant pressure on the stock price. If the stock gets pushed down into the mid-20s, it could certainly be a buying opportunity we will need to revisit.

The Actavis acquisition was a major event for the company last year. The $40 billion purchase of Allergan's generics arm and its integration has been smooth thus far. The deal was supposed to help compensate for weak parts of Teva's business and to reduce its reliance on the multiple sclerosis drug Copaxone that will soon be off patent and facing very tough competition. Actavis expands Teva's global footprint and should boost 2017 profits, giving the company a forward price multiple of seven times.

Yet, the challenges are mounting. The company has hundreds of generic filings pending Food and Drug Administration approval, with regulatory delays for some drugs clouding the outlook for its generics unit. Many analysts even see the Copaxone franchise as a tough one going forward since there is likely to be a generic version by the end of this year.

In addition, the company will pay a $520 million fine for an anticorruption investigation it settled in December. More importantly, without a major product launch coming soon, Teva's market share could continue to shrink this year. For the consumer, generic drugs are a great thing, but for Teva it means lower stock prices.

That being said, maybe Tepper and Paulson, both down approximately 20% in their positions, will be right in the end. The risk-reward with this stock, however, is too low to take a chance at this point.

Disclosure: I do not have a position in any of the stocks discussed in this article.

Start a free 7-day trial of Premium Membership to GuruFocus.

This article first appeared on GuruFocus.