Valeant Pharmaceuticals (NYSE:VRX) is a $22.5 billion pharmaceutical company that focuses on developing and distributing medicines for dermatology, neurology and other infectious diseases. It is trading at $72.81, near the top of its 52-week range of $42.47-$76.57 due to management's aggressive growth strategies. Valeant's expansion has been mainly driven by acquisitions, and I expect growth to continue until the end of 4Q2013.
When Michael Pearson, MBA, joined Valeant as CEO in 2008, he brought along his expertise as the previous director of the global pharmaceutical practice at the management consulting firm McKinsey & Co. Since 2008, Valeant's market cap has risen from $1.7 billion to $22.5 billion. Moreover, in December 2011, Pearson appointed Howard Schiller, former COO of the investment banking division at Goldman Sachs, as CFO. Schiller had significant experience in the global healthcare sector during his time at Goldman. Valeant's CEO and CFO have strong track records both in and out of Valeant, and I am confident they will continue to successfully grow the company. In most cases, historical stock prices should not be used to predict future prices. However, Valeant's stock has reflected the success of Pearson's business strategy, and its continued use will help the company continue to grow.
Valeant's revenues and gross margin show a strong positive trend. I expect this trend to continue through 2013 as Valeant integrates its operations with Medicis, a dermatologic pharmaceutical company that was acquired in September 2012. Medicis had revenues of $574 million between January and September 2012. Along with revenue growth, Valeant expects cost-rationalization and integration initiatives with Medicis to yield synergies of $300 million per year. The full effects are expected to be completed by the end of 2013. Valeant continued its growth strategy in 1Q2013 by completing three other material acquisitions: Obagi Medical Products (revenues of $121 million in 2012; expected annual synergies of at least $50 million); Natur Produkt (revenues of $65 million in 2011); and the U.S. rights to Targretin from Eisai at a fair value of $50.8 million.
Revenues, COGS, Gross Margins, Year-over-year
Revenues, COGS, Gross Margins, Quarter-over-quarter
Valeant's organic growth trends continued over the past quarter when revenues grew 8.3%. However, in April 2013, Mylan launched a generic version of Zovirax, a product that made up 7% of Valeant's sales in 2012, reducing expected cash EPS by 35-40 cents for 2013. Despite this, the revenues and cost savings that could be generated with the integration of previous acquisitions justified Valeant's increased cash EPS guidance, up ten cents from $5.45-$5.75 to $5.55-$5.85 after the 1Q2013 earnings release.
Supporting Valeant's high-growth strategy are its increasing R&D and acquisition spending. Valeant, which does not pay a dividend, is implementing aggressive growth strategies, which will increase organic growth through 2013. Significant amounts are consistently being spent on growth activities such as R&D and restructuring and acquisitions.
R&D and costs relating to acquisitions and integration, Year-over-year
Restructuring, integration and other costs, and acquisition-related contingent consideration
Interest Rate Risks and High Debt Levels
Valeant's debt to asset ratio is 0.795. Fortunately, a significant portion of their notes are based on LIBOR, U.S. Prime, and the Fed funds rate. In a low rate environment, Valeant is able to grow faster through acquisitions by taking advantage of the relatively cheap debt. Of the $10,756 million principal amount in debt, $4255.7 million is based on a variable rate. A 1% increase in rates would decrease pre-tax income by an estimated $31.8 million, a considerable amount compared to the operating income of $882 million in 2012. This effect would be enhanced by any potential downgrades to Valeant's debt due to high leverage levels. Furthermore, any cuts to the Fed's quantitative easing will increase interest rates and have drastic effects on Valeant's bottom line. Only 11% of economists surveyed by Bloomberg think the Fed will end bond buying in 4Q2013, while 39% predict QE will end in 1Q2014. Based on these estimates, I am looking to sell my shares in Valeant before 1Q2014 to mitigate interest rate risks.
On a similar note, Valeant's debt to asset ratio signals that the company may be overleveraged, and would need to decrease the speed of acquisitions in the future. However, in 2012, Valeant's cash flows from operations, $657 million, are well above their interest expense of $473 million, indicating that Valeant is still able to maintain acquisition spending through 2013.
The Bottom Line
Several factors point towards slowing growth for Valeant in 2014: the synergies from the acquisition of Medicis are expected to be fully developed by then, high debt levels may prevent additional acquisitions, and interest rates are expected to rise in starting in 1Q2014. Moreover, Valeant's $1.5 billion Securities Repurchase Program that started in November 2012 is ending November 14, 2013 (although the program is likely to be renewed).
Despite the risks Valeant faces in 2014, the company still has strong growth prospects in 2013. High earnings and revenue growth would be achieved as Valeant integrates and synergizes its operations with previously acquired companies, specifically, Medicis and Obagi Medical Products. Investors can also benefit from owning Valeant during the summer months, when dermatology sales typically increase due to the back-to-school season. I do not believe that the 22% YTD run is over yet. Expect Valeant's earnings to keep growing through 2013, but be prepared to take profits as Valeant may run out of steam in 2014.