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Teva Pharmaceuticals Had a Very Bad Day, in a Very Bad Year

In this Market Foolery podcast segment, host Chris Hill and Motley Fool One's Bill Mann consider how much worse Teva Pharmaceutical Industries (NYSE: TEVA) looks presently, after a second quarter report that featured weak sales, low profits, a 75% dividend cut, and -- to top it off -- a guidance reduction. The key difficulty for the company is that it's carrying too much debt for its size, amid an environment where its income is shrinking -- not a tenable position. But the stock is at a 13-year low. Is it a bargain yet?

A full transcript follows the video.

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Chris Hill: Let's move on to Teva Pharmaceuticals, which is the generic-drug maker which is having a really bad day.

Bill Mann: Having a really bad year. It's down 55% from its peak.

Hill: Down 20% today.

Mann: Some of that has happened today, yes.

Hill: Second-quarter profits came in low. Overall sales were light. They lowered guidance and they cut their dividend by 75%.

Mann: That sounds bad.

Hill: Other than that, Mrs. Lincoln, how was the play?

Mann: [laughs] That's right. So we were just talking about the danger of debt. The pharmaceutical industry is one of the greatest industries in terms of economics. You produce something that costs very little, and you get to sell it for a lot. But one of the issues in the pharmaceutical industry is that everybody knows this. Everybody understands the economics. So it's somewhat rare when you get, for a mature business, that type of great economic surprise. But the other thing that happens in the pharmaceutical industry is, because those cash flows tend to be so predictable, they can take out a lot of debt if they want to. It's an OK thing to take out debt if you generate a lot of cash and that cash is predictable. But if it's not predictable, you'd better hope that you can cover your debt.

The big issue with Teva -- Teva is now, I can do the math backwards, somewhere about $30 billion in market cap. All told between the revolvers and everything else, they have about $34 billion in debt, which they have to service. So when you read off the litany of things -- lower earnings, lower yields, lower cash flows, and AmerisourceBergen came out this morning and said across the board, generics in the United States are pricing about 7% lower than the same point last year. That hits them directly in the cash line. So Teva is now a company that's pretty severely in stress financially.

Hill: In terms of the dividend cut, if it's not the biggest financial red flag a company can wave, is it certainly in the top three?

Mann: It kind of depends. That's a great question. It depends on how a company treats the dividends. Now, Teva has treated their dividend as being somewhat statutory, by which I mean "The dividend is very important to us, and we would like to pay the same amount or increase it." So when they cut it, that's as much of a flag as you can get that they have a more important need for the cash. A lot of companies don't have statutory dividends. They say, "We'll try to pay out what we can." Then, you know, one year it's going to be this, or one quarter it's going to be that, it's going to move around a little bit. But for companies with statutory issues, the explanation for why they would cut it had better be, "We need that cash because we're about to do something awesome." Otherwise it's a sign of stress.

Hill: When you look at shares of Teva, which are now, as of today, at a 13-year low -- you have to go back to 2004 to find the stock this cheap.

Mann: Yeah. 

Hill: For anyone who's looking at it and saying, "Oh my gosh, it's down 55% for the year! This is on sale, I should snap it up."

Mann: Maybe. But what you need to understand is that Teva's debt is rated BBB. It's like the old Bugs Bunny, that joke -- watch that next step; it's a loo-loo. The step from BBB down means that they will no longer be investment grade, and that is a big problem for a company with that much debt. I think if you want to take a flier on Teva at this point -- it's crazy to say that for a company that's actually an enterprise value of $65 billion -- you've got to think about it like you're a credit analyst and not a stock analyst. That's a very different set of skills for a lot of people.

Bill Mann has no position in any stocks mentioned. Chris Hill has no position in any stocks mentioned. The Motley Fool recommends Teva Pharmaceutical Industries. The Motley Fool has a disclosure policy.