The Israeli drug company’s third-quarter numbers were worse than expected, coming in below already-reduced estimates, and the company again lowered its 2017 guidance. The company’s U.S. generics business is facing major challenges, including a faster pace of approvals for competitors and a weak pricing environment.
Fitch lowered its rating from BBB-minus to BB, a two-notch downgrade into high-yield, or junk, status, and kept the outlook at negative, meaning it could downgrade the rating again in the medium term.
CreditSights said it will be difficult for the company to hold on to investment-grade ratings from Moody’s and S&P Global Ratings.
“S&P appears ready to grant Teva
time to stabilize operations and reduce leverage,” said analyst Eric Axon. “Moody’s response, however, appeared to leave the door open for additional action.”
See also: The generic drug bloodbath continues for a second day, with Teva leading the way
Both credit-rating firms have outlined ways the company can reduce leverage, namely through actions including asset sales and equity or hybrid issuance, suggesting the company has the means to avoid downgrades.
“We advise investors who can withstand a potential downgrade to hang on, and would view additional downgrade-related forced selling as a buying opportunity.”
However, the market is currently pricing in almost a 100% chance of a drop to high-yield, said Axon.
“We advise investors who can withstand a potential downgrade to hang on, and would view additional downgrade-related forced selling as a buying opportunity,” said Axon. “If downgrades ensue, we ultimately expect Teva to settle at BB, given its free cash flow profile and ability to self fund near-dated maturities (to some extent).”
Teva’s most active bonds, the 3.150% notes that mature in October of 2026, were last trading at 85.97 cents on the dollar to yield 5.134%, according to MarketAxess. The bonds were trading above 88 cents on the dollar on Monday before the downgrade. On a spread basis, they are trading at 282 basis points over comparable Treasurys.
The company’s 2.800% notes that mature in July of 2023 were trading at 88.32 cents on the dollar to yield 5.193%. Those notes were above 91 cents on the dollar before the downgrade.
Teva has about $35 billion in debt, with about $29 billion of that sum in the form of bonds, according to FactSet data. Fitch said the company is facing “significant operational stress” at a time when it needs to reduce debt taken on the finance its August 2016 acquisition of Actavis’ generic drug business.
“Pricing pressure in Teva’s North American generics segment and erosion of sales of Copaxone will continue to weigh on free cash flow in the near term, requiring the company to continue to sell assets or find external capital resources to meet debt obligations in 2018 and 2019 and beyond,” said Fitch.
Copaxone is Teva’s best-seller, a multiple sclerosis treatment that is facing competition from a generic made by Mylan NV that was approved in October, earlier than either company expected. The drug accounted for more than $4 billion of revenue for Teva in 2016.
Fitch is expecting gross leverage for Teva to remain above 5 times by year-end 2019. The agency said it would need to reduce leverage to below the 4.0 times level to merit an investment-grade rating, but that seems unlikely even including asset sales.
On the equity side, Teva shares have lost 67% of their value in 2017. The SPDR S&P Pharmaceuticals ETF
has gained 2.9% in 20178, while the S&P 500
has gained about 16% and the Dow Jones Industrial Average
has gained 19%.