Valeant Pharma: Why This Bear Still Growls

By Johanna Bennett, Barron's

Photo: Shutterstock

It's been a big week for Valeant Pharmaceuticals International ( VRX ). The troubled drug maker released estimate-beating third quarter financial results  earlier this week that had many, even some of the biggest bears  on the stock, commending the headway Valeant has made in streaming the company, fixing its balance sheet and getting new drugs approved.

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The market has rewarded the stocks. Shares of Valeant have surged almost 31% over the past five days.

Even Wells Fargo's David Maris , who has rated Valeant at Underperform since February 2016 when the share price sat above $94, concedes that "Valeant has made some progress that should not be overlooked - like getting Siliq and Vyzulta approved."

But Maris isn't backing away from his bearish stance.

Overall, we do not think 3Q was strong for Valeant, and we believe the positive market reaction is unwarranted.

Why? The note Maris published listed a litany of shortcomings in Valeant's earnings report, including a 20% drop in R&D spending, falling sales in its dermatology business and the pile of debt that remains on Valeant's balance sheet.

Maris is also concerned about further margins decline in 2018 as more branded drugs lose patent protection.

...we would wait on thinking that Dermatology is fixed or that Valeant can robustly launch new products. Adding to our caution is litigation/investigation risk, as Valeant continues to have a wide array of pending suits and ongoing investigations.

He goes into more details on these concerns.

Sales declined 10% YoY, and R&D spending is -20% YoY. We cannot help but to think that a drug company that spends 4% of its revenue on R&D and still 20% lower than the year before is unlikely to have enough winners to offset the normal LOEs. Dermatology sales declined 34% YoY. The company highlighted several times how it has paid down debt ahead of its own schedule, but according to our estimates, leverage is higher now than it was a year ago or last quarter. Total debt to TTM adj. EBITDA by our calculation is now 7.20x vs. 6.65x a year ago, and is also higher sequentially (vs. 7.15x in 2Q17).

On margins for 2018, Valeant indicated that while it will not provide guidance for 2018, the LOEs are very high margin and based on that one can directionally see the impact. We took that to mean margins are likely to further decline in 2018.

On taxes, Valeant indicated that the proposed tax reform plan outlook is far from clear, but noted if passed as written it could potentially have a significant impact on Valeant. Valeant indicated that it is very pleased with its flexible tax position, and would hope to mitigate some tax increases with potential tax mitigating moves, but did not provide any details as what these might be. Valeant noted that the largest potential impact could be from the proposed 20% excise tax. Valeant management announced at the luncheon that they are reasonably sure Valeant will pay more in US taxes almost no matter how the tax reform proposal is enacted. We believe that Valeant will likely face higher taxes in the future than in the past.

At $15.24 a share, Valeant is down 0.72% today and down more than 9% over the past 12 months.