Here's What's Behind Valeant Pharmaceuticals' 13% Drop

A businessman giving the thumbs-down sign.

What happened

Shares of Valeant Pharmaceuticals (NYSE: VRX) , the embattled drugmaker that's primarily grown through price hikes and acquisitions this decade, tumbled as much as 13% on Thursday after receiving a premarket rating downgrade from J.P. Morgan Securities.

So what

The investment firm lowered its rating on Valeant Pharmaceuticals to "underweight," which is pretty much the equivalent of a "sell," from "neutral," which is where its opinion of Valeant had sat for more than a year. It there is a bright side here, J.P. Morgan did increase Valeant's price target by 20% to $12 from $10 (albeit the stock had climbed to north of $22 at yesterdays close).

Why the downgrade? Analysts cited the company's still high debt levels as cause for concern. They noted that debt leverage will remain challenging at roughly seven times equity when the ideal figure viewed by Wall Street for Valeant is closer to four to five times equity.

Additionally, J.P. Morgan noted concerns about upcoming patent expirations in 2018, which will adversely impact EBITDA (earnings before interest, taxes, depreciation, and amortization). This is a result of Valeant's previous practice of acquiring mature medicines and relying on price increases to fuel growth. It's left the company with a portfolio of medicines nearing the end of their exclusivity period.

Now what

The important thing for investors to remember here is that Wall Street's musings rarely impact the share price of a company for more than a few days. Rating upgrades and downgrades are very short-term price drivers, and that's not what we're all about. We much prefer to look at the bigger picture and analyze where the company might be five or more years from now.

With that in mind, Valeant does have significant challenges on the horizon with regard to further reducing its debt to manageable levels and re-igniting its growth engine. Though its third-quarter earnings report signaled that it's already surpassed its February 2018 debt-reduction target, CEO Joe Papa has also commented that the company is done with near-term divestitures. Considering that nearly all of its operating cash flow is going to service the interest and fees on its debt, it leaves little left over to make a dent in its debt pile.

Similarly, we've witnessed solid organic growth from Valeant's core segments (Bausch & Lomb and Salix Pharmaceuticals), but its other operating segments have lagged. The company will need to correct that to really get the optimists back on board.

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Sean Williams has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Valeant Pharmaceuticals. The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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