Thursday, March 4, 2010

Accounting Gimmicks not Limited to Government: Focus on Teva

Regular EBR readers know that going back to some months from the March 2009 stock market bottom, I commented that the best stocks from my standpoint going forward were ones with structurally strong charts. Prominent amongst them was Teva Pharmaceuticals (TEVA), which has been mentioned positively here several times thereafter. There is a downside to Teva shared by numerous other companies. Now that Teva has justified my faith, I have sold all my shares in it, because I mistrust its earnings presentations in that its P/E is actually quite high. Teva has become a glamor stock masquerading as a low P/E value stock.

In Teva's last earnings release, it reports results for full-year 2009 and the last quarter.

Here is one of the highlights:

* Quarterly non-GAAP net income and non-GAAP EPS of $847 million and $0.94, up 28% and 18%, respectively, compared with the fourth quarter of 2008. Quarterly GAAP net income and EPS totaled $379 million and $0.42, respectively, compared with a loss of $694 million and a loss of $0.88 per share in the fourth quarter of 2008.

Here is some of the company's commentary:

Non-GAAP net income and non-GAAP EPS for the fourth quarter of 2009 are adjusted to exclude the following items:
* Legal settlements of $379 million;
* Amortization of purchased intangible assets and inventory step up of $139 million;
* Impairment of assets of $71 million;
* Restructuring charges and acquisition costs of $25 million;
* Purchased in-process R&D of $23 million;
* Other net financial income of $8 million; and
* A related tax benefit of $161 million.

For Teva to pretend that legal settlements are not part of normal operating results is asking too much. Everyone who knows the generic industry knows that that is an important part of the business. Similar, restructuring is a real cost. Closing a high-cost factory to relocate in India has a cost and is a regular part of the ongoing business. Certainly the upcoming cost savings that increase operating margins will not reciprocally be claimed as one-time profit gains.

(One can decide what one wants about the appropriateness of excluding amortization of intangible assets from an earnings presentation, or impairment charges.)

If one looks at Yaoo's standard array of quick facts for TEVA, one will see a P/E (trailing) of 26.96. This likely incorporates GAAP accounting. Yet if one goes to "Analyst Estimates" on the same site, one will find the non-GAAP "earnings" for Q4 2009 of $0.94.

Teva is hardly alone. Bristol-Myers (BMY) in the same industry has similar though less dramatic differences between GAAP and "headline" earnings. Of course, none of this is limited to the pharmaceutical industry.

It is GAAP that was correct in the valuation of Fannie Mae and Freddie Mac before they collapsed.

After its latest price surge, Teva trades at a rich multiple of tangible book value, sales, and dividend payout.

Teva has recently disclosed a multi-year 13% or more growth target.

It would appear that it has done a great job promoting its stock. The stock certainly has momentum.

However, its size, at $53 B market cap, makes it too large for almost any brand company to acquire, so it is not clear what the exit strategy is. The dividend yield is a trifle above 1% despite a recent dividend hike. The stock sells for over 20X tangible book value.

It just may be that Teva's generic products offer better real value than does the stock given GAAP accounting and with attention paid to real assets rather than assets accounting for intangibles.

Copyright (C) Long Lake LLC 2010

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