The Leverage Labyrinth
We believe the gap between Teva Pharmaceutical’s (TEVA) headline leverage ratio and reality is widening
Teva Pharmaceutical’s (TEVA) new Pivot to Growth plan has dramatically changed Wall Street’s impression of the generic pharmaceutical company which has resulted in its stock breaking above $13 for the first time since its string of massive disappointments in 2019. We will not do a deep dive into the Pivot to Growth plan and its likelihood of success at boosting growth. However, a careful look at the company’s balance sheet, financial footnotes, and contingency section makes us believe that investors should still be focused on cash flow, actual leverage position, and earnings quality and not get carried away by promises of an uptick in EPS increases.
We have touched on TEVA’s true leverage ratio in past articles including Debt by Any Other Name. However, we saw several warning signs in the fourth quarter results that make us believe the cash flow situation is worsening and the company’s leverage picture is dramatically more dire than the figures offered by management in its presentations would indicate.
The first warning sign we saw in the quarter was the company’s forecast for 2024 free cash flow of $1.7-$2.1 billion. TEVA managed to report only $2.4 billion in free cash flow in 2023 despite a $430 million unexpected one-time payment from Sanofi and numerous other likely unrepeatable benefits we will discuss below. However, the company focuses investor attention on its adjusted EBITDA number and utilizes that as the basis for its advertised leverage ratios. Like free cash flow, 2023 EBITDA received multiple benefits that are not likely to repeat in 2024. In addition, the company’s sizeable non-GAAP adjustments make for what we consider to be a very unrealistic number.
On the subject of non-GAAP adjustments, it is worth noting that the spread between TEVA’s GAAP and non-GAAP numbers is enormous, particularly for an established generic pharmaceutical player. GAAP EPS for 4Q was only 41 cents vs. the $1.00 in non-GAAP EPS. For the year ended 2023, GAAP EPS was a loss of 50 cents against the reported $2.56 in profit. This fact alone makes the quality of TEVA’s adjusted earnings very suspect in our opinion, and we will take a closer look at the quality of fourth-quarter earnings below.
We believe TEVA makes an excellent study into how accounting assumptions, unusual benefits, and unrealistic adjustments can lead to very misleading EPS, cash flow, and measures of effective leverage.
Let’s get Behind the Numbers…