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Valeant Pharmaceuticals Intl Inc (NYSE: VRX ) has been on a tear in recent months, nearly doubling since November 1, when it closed at $11.93 a share. It performed well in the third quarter. Valeant announced its results on November 7, with the news it beat analyst estimates for both revenue and net income.
The company has also made progress in reducing its substantial debt burden. During the earnings call , CEO Joe Papa noted that Valeant had reduced its total debt by $6 billion since January 2016, exceeding its commitment to pay down $5 billion by February 2018.
Last March, I described the company's controversial past . Valeant borrowed money to buy pharmaceutical companies and sharply raise drug prices. This strategy worked until a political firestorm was ignited in September 2015. The fund manager Martin Shkreli bought the rights to an anti-parasitic drug, Daraprim, raising the price 5,500%.
Presidential candidates quickly condemned this, and drug companies drew Congressional scrutiny. This made Valeant's strategy no longer workable. VRX stock fell sharply, and then-CEO J. Michael Pearson stepped down in March 2016.
Since then, VRX has focused on cleaning up its balance sheet, selling off assets to reduce its debt burden. Valeant announced on January 3 that it had paid off an additional $300 million in debt .
So, has Valeant stock turned a corner?
VRX Stock Pros
Leadership : Valeant needed a leadership change in 2016, and brought aboard Joseph Papa, the CEO of Perrigo Company plc (NYSE: PRGO ), a manufacturer of over-the-counter drugs. As Valeant said at the time, Papa brought with him 35 years of experience in the pharmaceutical industry.
Papa purchased Valeant stock and announced his plans for stabilizing the company and reducing debt. So far, he has followed through.
Bausch and Lomb : Some 57% of Valeant's revenue in the third quarter came from its Bausch and Lomb division, which sells contact lenses. Bausch and Lomb is popular on e-commerce platforms such as Amazon. During Valeant's earnings call, Papa stated that sales on Amazon grew 69% last year.
Papa also noted the opportunities for Bausch and Lomb in Asia. According to Peter Tan of SeekingAlpha , Bausch and Lomb is the top brand among e-commerce websites in both India and China , two fast-growing markets.
Lower Debt : As mentioned earlier, Valeant has made progress in reducing its debt burden to $25.7 billion. No Valeant debt will mature until 2020, giving the company two years of breathing space.
Valeant is issuing unsecured notes and using the proceeds to pay off secured debt. Secured debt may get in the way of Valeant's divestitures, since the loans are backed by some of Valeant's assets. The interest rate on unsecured debt is higher, but this gives Valeant greater flexibility in divesting assets.
Papa told the Canadian business channel BNN that his goal isn't to eliminate Valeant's debt, but to reduce it to the range of $15 billion to $20 billion.
VRX Stock Cons
Analyst Opinion : Analysts aren't too bullish on Valeant stock. They currently rate Valeant as a "hold," with a price target of $16.57. If Valeant stock were to fall in line with their estimates, investors would realize a 30.5% loss.
Regulatory Risk : Valeant may have turned a corner, but its past misconduct could always come back to haunt the company. Deutsche Bank analyst Greg Gilbert noted the uncertainties around Valeant's "potential cost of past sins."
In August, the investment company Lord Abbett & Co., which had purchased Valeant debt, sued Valeant for $80 billion in damages , alleging securities fraud. This is more than three times Valeant's current debt burden.
Lord Abbett also alleged violations of New Jersey's racketeer influenced and corrupt organizations (RICO) law. As Greg Farrell and Neil Weinberg note in a Bloomberg article, "The existing securities fraud cases against Valeant, which claim a comparable total of investor losses, don't contain the RICO threat of treble damages.
"If other investors were to follow Lord Abbett's lead, Valeant's legal exposure could balloon."
Florida's state pension fund is also suing Valeant for $62 million in losses, alleging fraud.
Stock Price Surge : Even if Valeant really may have turned a corner in recent weeks, it is difficult to argue that this isn't priced in to the stock, which has more than doubled.
VRX Stock: The Verdict
Valeant stock trades at 6 times earnings, 6.63 times forward earnings, 0.92 times sales and 3.91 times free cash flow. Given these low valuations, some investors might be tempted to buy Valeant stock in the hope that it appreciates further.
I don't quite agree. A stock like VRX may appear cheap to some observers, but appearances can be deceiving.
True, a market capitalization of $8.21 billion might seem small for a pharmaceutical company generating $1.38 billion in annual profits. But keep in mind that Valeant's enterprise value, which includes debt, is much higher: $33.3 billion.
And keep in mind Valeant's potential legal liabilities.
But VRX isn't the only pharmaceutical stock which has underperformed since August 2015. Since the drug-pricing furor erupted, the sector as a whole hasn't done very well.
The SPDR S&P Pharmaceuticals ( ETF ) (NYSEARCA: XPH ) has lagged the Nasdaq Composite (INDEXNASDAQ: .IXIC ) over the past two years.
There might be undervalued pharma and biotech stocks flying under the radar.
If you choose to look for some, I would steer clear of companies producing opioids, since that could be the source of the next controversy. Opioids include prescription painkillers and illegal drugs such as heroin.
According to the U.S. Centers for Disease Control and Prevention , the number of deaths from opioid overdoses has quadrupled since 1999. The U.S. Department of Health and Human Services labels this an "epidemic".
Drug companies could be held liable for this.
13D Research warns that this could "topple titans of the pharmaceutical industry" and that "total settlements could far eclipse the roughly $250 billion paid by the tobacco industry two decades ago."
As of writing, Lucas Hahn did not hold a position in any of the aforementioned securities.
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