Valeant Pharmaceuticals Intl Inc stock is extremely risky, but on the other hand, it also carries a high reward.
Shares of specialty pharma company Valeant Pharmaceuticals Intl Inc (NYSE:VRX) have tanked more than 20% in last two trading sessions, breaching the support from the 50 day SMA, after the Laval, Quebec-based company reported its Q4 and FY 2016 earnings on Tuesday, before the market opened. While the earnings itself were better than expected, the guidance for FY 2017 didn't go down well with investors and wall street, earning the company multiple price target cuts. Valeant reported an adjusted profit of $1.26 a share against analysts' estimate of $1.21. This was Valeant's first beat in a long time. Even on the revenue front, the company reported better than expected results. Initially, the stock gained on the report of an earnings beat. However, once the guidance figures came in, the stock tanked. In our earnings preview of Valeant, we had said that the adjusted EBITDA guidance for 2017 will be the key driver of VRX stock after the earnings.
Valeant's financials will continue to deteriorate.
Valeant's Q4 revenue was down 13% YoY while adjusted EBITDA declined by 24%. The decline in revenue was primarily driven by a reduction in product sales and forex impact. Valeant took a hit of $310 million from the reduction in product sales from the existing business and another $43 million hit due forex, most notably from the Egyptian pound, which was significantly devalued in November 2016. Revenues in the quarter were further impacted by a drop in realized pricing by 3%, along with divestitures and discontinuations of $16 million. For the full year, Valeant's revenue fell by 7%, while adjusted EBITDA declined by 20%. And the decline is likely to continue in 2017.
In 2017, Valeant expects revenue to come in between $8.9-$9.1 billion (midpoint of $9 billion) slightly higher than consensus estimates of $8.98B. However, the company disappointed on the adjusted EBITDA front. Valeant guided for adjusted EBITDA to come in between $3.55-$3.70 Billion. Even at the higher end of the range, adjusted EBITDA guidance falls short of analysts' estimate of $3.88 billion. At the midpoint of its guidance, Valeant is precariously close to breaching its debt covenant. According to the updated terms of agreements with its debtors, Valeant needs to maintain a minimum interest coverage ratio of 2. Based on its guidance for cash interest expense of $1.75 billion in 2017, and the midpoint of its adjusted EBITDA guidance, Wells Fargo’s David Maris expects an interest coverage ratio of 2.07x, which is very close to the 2x interest coverage covenant. And while the management said that the guidance was on the conservative side, it doesn't appear so. To quote Mizuho’s analysts Irina Koffler and Andrew Galler from their report:
"It still doesn’t appear that mgmt. has a realistic outlook on its organic growth and guided to 2-5% growth in its Branded Rx business and 5-7% growth in its B&L franchise in 2017 (in its slides), in spite of 12.1% Y/Y declines in Brand in 2016, and flat performance in B&L. We reiterate our Underperform rating...."
Leverage likely to increase in spite of asset sales.
When Valeant had announced its plans to sell of assets worth $2.1 billion in January, VRX stock had rallied, based on the expectation that the sale will bring down the leverage. However, that's not the case. Valeant only managed to pay off $1.2 billion in debt in 2016, so leverage spiked to 6.9x versus the already high 5.8x in 2015. For 2017, the leverage is tracking even higher. Even after subtracting $2.3 billion from total debt, assuming the entire proceeds of the Dendreon and CeraVe sales go to debt pay-down, Valeant's leverage is likely to come in around 7.5x adjusted EBITDA. This puts even more pressure on the management to be careful while divesting the assets. The company should avoid selling its best assets unless it gets a very lucrative offer.
It has been a roller coaster year for shareholders of Valeant pharma (just like the previous year). Valeant stock gained almost 12% by Jan 10th, but then, it crashed 20% by the end of January. The stock again rallied by 25% from the beginning of February till the earnings before crashing by 20% in the two days after earnings. Such huge volatility makes the stock risky.
Adding to the risk is the fact that, even according to the company's guidance, Valeant has a razor-thin safety margin on its interest coverage ratio front. Any breach of the covenant will trigger a technical default, sending the stock crashing down. Valeant still has a long road ahead of it. The stock is extremely risky, but on the other hand, it also carries a high reward. Wall Street has a price target of $22.29 on the stock, an upside of 64%. Get in only if you have an appetite for high risks. Valeant stock is not an investment, it a speculative bet.