TEVA, despite recent weakness in share price, bonds trade tight in light of expected deleveraging

All,

We have updated our model here

We exited our position in the Euro 27;s in mid August and despite the current weakness in the share price, the current yield on the debt structure is not attractive enough for us to consider taking a long position. We continue to expect the Company to deleverage but with yields inside 5% we question the further upside. Teva has shown significant deleveraging over the last 4 quarters, with growth in Ajovy and Austedo drugs compensating for the decline in Copaxone.

The opioid trial still hangs overhead for Teva, and although we are comfortable that Teva has the ability to survive and continue to deleverage post fine, there is still the risk that the trial drags on and doesn't reach a timely conclusion. A settlement, even at higher levels, similar to the Johnson & Johnson proposed settlement would actually be positive for the bonds. The management still expect a settlement in the short term, they were less confident on recent conference calls than in early 2020. According to our research the damage inflicted from a potential settlement of the Opioid trials could amount to an annual $800-1000m cash drag. The company would still be deleveraging with that fine and thus we are confident about Teva’s overall future. The focus on the conference call has moved on from the litigation and majority of questions centred on future prospects of existing and potential new drug lines.

Under our model, we have the Company breaching covenants in late FY22 but the Company has guided to overall leverage in FY23 to be 3.0x. Our model is conservative on the margin improvement expected by management, but given their recent records, it is likely the Company will see improving Gross Profit margins going forward. Given the cash balances coupled with the deleveraging of the Company, waivers from the RCF banks should be forthcoming, especially as payment of fine indicates clarity over the overall opioid litigation. A breach might be avoided depending on the accounting treatment of the costs and "selling price" of the free drugs.

Happy to discuss, but for now we don’t see any opportunities. Given the weakness in the share price, a long equity short credit trade would benefit from any resolution to the outstanding litigation, but with no short term motivation from looming court dates, settlement agreement is likely to drift into 2021.

Tomás
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