Questcor Presents Compelling Risk / Reward At $33

| About: Mallinckrodt PLC (MNK)

Questcor Pharmaceuticals (QCOR) has had an interesting ride since September 2012, when Citron Research released this bearish report on the company. Citron's report said that Aetna, a leading healthcare insurance provider of Questcor's, would be significantly reducing coverage of the company's leading drug Acthar.

This report caused quite a stir with the public markets and the stock reacted by dropping from the mid $50s to $17 per share. Since then shares have recovered to $33, but remain a long way from high's preceding the report.

Specifically, Citron's report said that on September 14th Aetna had stopped reimbursing payments for Acthar for all uses, except infantile spasms (which account for just 5% of subscriptions). If true, this would be a major blow to the potential reimbursements for the other 95% of Quesctor's revenue.

What has happened since? Basically nothing. In fact Questcor continues to deliver blowout financials. On October 23rd Questcor reported phenomenal Q3 numbers that beat analyst EPS estimates by $0.14 and topped revenue by $11M. Although there where only 2-3 weeks in the quarter where Aetna's new policy would have been in effect, it clearly had no impact on Q3.

On December 6, 2012, Citron published another negative research piece on Questcor. The report highlighted a study from Prime therapeutics that concluded 96% of Acthar use was unnecessary. The survey only targeted 30 patients (there are several thousand total), and had a very limited effect on the stock. Either way, Citron continued to tout the uselessness of Acthar, and question its long-term viability.

Curiously Q4 numbers reflected no disruptions from Aetna's new policy, or the study from Prime Therapeutics. In Q4 Questcor reported EPS $0.12 above analyst expectations and revenue $18M above. Another blowout quarter.

So what's happening? It's clear that either Citron was dead wrong on this one, or there is a serious 6+ month lag from declining patient satisfaction to Questcor's financials.

Interestingly enough, estimates for Questcor's financials have risen steadily since the September shock. Estimates for 2013 EPS have risen from $4.05 to $4.29 (+6%), and estimates for 2014 EPS have risen from $4.58 to $5.16 (+13%). Analysts aren't pricing in any effects from reduced Acthar uses for at least another 24 months.


Even though Questor's financials have remained impervious to supposed Acthar shortcomings, the stock has not. For this reason shares trade at an absurdly cheap P/E ratio. Management has taken a very active approach to combat this disconnect in valuation and growth, by initiating a dividend and share buybacks.

Questcor has been buying back stock for several years, and still has 6M+ shares available on its current plan. That is good enough for 10-12% of all shares outstanding. Besides buying back an enormous amount of stock, management issued a dividend shortly after the stock crash to help investor confidence. The quarterly dividend was $0.20 when initiated, representing a yield of 2.5%. In Q4 the company raised its dividend by 25% to $0.25 per share, increasing the yield to 3.13%.

Shares currently trade at a P/E of just 7.5x (2013), and a forward P/E of 6.2x (2014). Questcor's current payout ratio of 20% is low and could easily be raised in the near future, especially if earnings continue to rise.

Questcor has no debt and over $150M in cash on its balance sheet giving them plenty of financial flexibility. As the company adds cash to its books and continues to aggressively increase shareholder value, Questcor offers a compelling risk/reward scenario. The market is clearly pricing in a downturn in Acthar sales (reason for such a depressed valuation). If Questcor can deliver knockout results for a couple more quarters then the stock's hangover may eventually go away.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.