Shares of Valeant Pharmaceuticals (NYSE: VRX), a drugmaker that has predominantly grown via acquisitions over the years, plunged by 18% during August, according to data from S&P Global Market Intelligence. The standout reason for Valeant's poor performance looks to be its Aug. 8 second-quarter earnings release.
Continue Reading Below
On the surface, Valeant Pharmaceuticals delivered a number of key improvements in its second quarter. To begin with, the company's two core operating segments both delivered strong organic growth. Organic sales at Bausch & Lomb grew by 6%, while Salix Pharmaceuticals, which specializes in drugs to treat gastrointestinal disorders, delivered 16% organic sales growth. It's no secret that Valeant needs its core businesses to grow in order for the company to once again grow its EBITDA (earnings before interest, taxes, depreciation, and amortization) and to pay down its $28.5 billion in debt, as of the end of Q2. This recent quarter suggests there's hope of EBITDA stabilization and possibly growth in the future.
Valeant also delivered an improvement in its EBITDA-to-interest coverage ratio, which is the debt covenant used by its secured lenders to determine the safety of their loans. In the latest quarter, Valeant wound up reporting $951 million in EBITDA and $456 million in interest and fees to service its debt -- a ratio of 2.08-to-1. That's up from 1.83-to-1 in the sequential first quarter. Additionally, the company is on track to meet its $5 billion aggregate debt-reduction target by February 2018.
So, what's the issue? Look no further than commentary from CEO Joe Papa during the second-quarter conference call with analysts that the company is done (at least for now) selling non-core assets to reduce debt. Even with the recognition of the Dendreon, iNova Pharmaceuticals, and Obagi Medical Products divestments, Valeant is still going to be lugging around between $26 billion and $27 billion in debt by year's end. With much of its free cash flow being funneled into servicing its debt, very little cash is left over to actually pay down debt and reinvest back into the business. In other words, investors are clearly questioning the feasibility of Valeant's strategy to allow its existing product portfolio to drive an organic pay-down of its debt.
At this point in time, this writer believes the skeptics have every right to be worried about Valeant's future, even after its recent debt-reduction efforts. For example, even with growth in the company's core operating segments, other divisions, such as dentistry and dermatology, delivered sales declines of 20% and 31%, respectively, on a constant currency basis during the latest quarter.
Valeant's growth has also been stymied in recent quarters by a lack of pricing power after now-former CEO J. Michael Pearson admitted to "mistakes" in the company's pricing practices with two cardiovascular drugs, Nitropress and Isuprel, in front of a Senate committee. Both drugs were acquired in February 2015 and had their list prices raised a respective 525% and 212% following the acquisition.
The age of Valeant's drug portfolio is also a bit concerning. Prior to its meltdown, the company had regularly been acquiring maturing drugs and relying on price hikes to boost their performance. Unfortunately, a number of these drugs are set to face generic competition in the next few years. When Valeant was able to use its debt-financed merger-and-acquisition growth strategy, replacing drugs that lost their exclusivity wasn't a concern. Without access to new credit, it now is.
And, of course, there's the very real concern that Valeant won't make much headway on its debt without selling additional assets. There are still far too many questions and few answers with this company, which makes it a stock that I believe investors should avoid.
10 stocks we like better than Valeant PharmaceuticalsWhen investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*
David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Valeant Pharmaceuticals wasn't one of them! That's right -- they think these 10 stocks are even better buys.
Click here to learn about these picks!
*Stock Advisor returns as of September 5, 2017