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Questcor Pharmaceuticals (QCOR) has been one of the most volatile stocks in the sector. The stock has had countless ups and downs in the past six months, and it has mainly traded on the news. It is somewhat unusual for a company with an established history of revenue growth and earnings to have such wild swings in price based only on news. However, in Questcor's case, it has happened more than once, and the stock has been on this bumpy road before.

Insurance coverage for a drug plays a vital role in its sales, and especially, if the company has such an expensive product as Acthar; it becomes even more important. The first hit was due to Aetna's (NYSE:AET) slight modification in its policy, which suggested that the insurer may stop offering coverage for Acthar. As a result, the stock lost more than 50% of its value, and it has still not been able to regain most of that lost value.

In my opinion, Questcor is extremely undervalued at the moment, and the market is putting too much focus on the news. If we look at the business and future growth prospects of the company, then it is obvious that Questcor is selling for much lower than its fair values.

Business, Growth and Future Growth Prospects

The company has shown exponential growth in the past three years, and grown its revenues from $115 million in 2010 to $509 million in 2012. During the same time period, free cash flows for the firm have grown from mere $36 million to $218 million. There are few companies that can boast such impressive growth figures. Further, the business model of the company is incredibly strong. Acthar gel is prescribed for a number of conditions - multiple sclerosis and Nephrotic Syndrome being the two most important in terms of revenues.

Acthar falls in the orphan drug category, which allows Questcor to charge a premium price for its product - fears about insurance coverage also arise from the high cost of the drug. A portion of sales for Questcor comes from Medicaid and Medicare programs, for which the rebates are offered. The biggest negative for the company is its dependence on a single product for its revenues. It is a big deterrent for investors. However, in my opinion, if you have such an effective product; it's not too bad to rely on a single product. Nonetheless, the company is actively trying to add more conditions to the label, which should further widen the scope of the drug. At the moment, the company is experimenting with four conditions that can be treated with Acthar - if these trials are successful, more doors will open for revenue growth.

Let's now look at the future growth opportunities and whether the company will be able to continue its impressive growth or not. In order to exploit growth opportunity, companies need to spend more on research and development - Questcor has recently allocated more capital to research and development, indicating that the company believes a substantial growth opportunity exists. Acthar is an orphan drug, a status which allows Questcor to charge such a high price - markets for orphan drugs are usually small, which was also true for Acthar when the company started selling the drug for Infantile Spasms. However, Infantile Spasms is one of the many conditions Acthar can be prescribed for, and it contributes a small portion of total revenues. As a result of adding different conditions to the label, the company has been able to substantially increase the market size for Acthar - charging the same price that is charged by the orphan drug category.

These conditions separately have small markets; however, together, they have made a large market for Acthar. The strategy is paying handsomely for Questcor at the moment - keep adding more conditions and market size will keep growing, essentially providing the growth in the short term as well as long term. For investors, the strategy is extremely effective; however, some insurers and short sellers have started to doubt the potential of the drug. Personally, I believe Questcor will carry on with its strategy and the company will collect substantial benefits. I do not believe the growth will slow in the short term. Acthar is an extremely effective and vital drug, for which insurers will keep paying.

Dividends, Cash Flows and Valuation

Questcor has also started paying dividends - the company pays an annual dividend of $1 per share, yielding 3.30%. The company started paying dividends in September last year, and it has already increased dividends by 25%. Strong cash flows are important for maintaining dividends, and recent increase indicates that the company is extremely confident about the future cash flows. As I mentioned above, free cash flows of the company currently stand at $218 million while cash dividends for the last year were $24 million.

Since the company started paying cash dividends in the latter half of the year, I will take payout ratio based on the expected future dividend payments. Based on the current dividends, payout ratio for the company will be below 30% if we take current free cash flows. However, growth in future free cash flows should further bring down the payout ratio.

Questcor is trading at a P/E ratio of 9.8, compared to the industry average of 57.1. The stock is substantially undervalued - the market is ignoring future growth potential, and the stock is more responsive to news at the moment. In my opinion, the stock should gain substantial value during the current year (It has already gained over 15% this year).

Conclusion

Some stocks become victims of negative sentiment and manipulation, and Questcor is a prime example of such stocks. It is one of the most heavily shorted stocks at the moment, which might explain why the stock has been beaten down. If we look at the business and growth opportunities of the company; we see that there is substantial upside potential. It has a solid business model, an important product and strong financial position. In my opinion, the stock is set to move up in the coming months.

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.

Source: Questcor: More Focus On News, Less On Business?