Valeant: Now A Compelling Long-Term Play

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 |  About: Valeant Pharmaceuticals International, Inc. (VRX), Includes: ELN, GSK, TEVA
by: ValueMax

At a time when the entire pharmaceutical industry is presented with the conundrum of a steep patent cliff, Valeant (VRX) is a good bet for diversifying risk not only in terms of markets wherein it operates, but also the products it sells. Few companies have a mix of both generic and proprietary drugs, making Valeant a relatively 'safe' bet as far as long term income opportunity and stability goes.

What is not working in favor of Valeant, despite being one of the most popular pharma stocks out there, is the expensive valuation. With over 100 times price earnings, the stock is not cheap to say the least. Other stocks such as ISTA (ISTA) (although it's a small cap compared to the over $16 billion of market capitalization at Valeant) and Elan (ELN) are a much better bet pricing wise. In particular, Teva Pharmaceuticals (TEVA) is trading at under $50 with a much cheaper pricing multiple of about 15 times.

Interestingly, Valeant had made an attempt to buy ISTA Pharmaceuticals earlier in 2011, raising its offer of $6.50 a share to $7.50. The deal didn't work out, and ISTA has now moved to Bausch and Lomb, a privately held company specializing in opticals. That aside, Valeant pharma has been hot on the acquisitions trail, making as many as 8 acquisitions in the previous fiscal alone. Key acquisitions included Dermik, Sanitas and PharmaSwiss among others, which in great part have contributed to the more than doubling of revenues for the latest fiscal year report.

As an analyst, I personally like to look at operational items more closely than non-operational items, simply because they depict a more accurate picture of the company's ability to earn money and create cash flow. As such, Valeant pharma does show a bit of instability in operational earnings over the years, ranging from a loss of $110 million for the fiscal 2010, with a profit of almost $300 million in 2011. Acquisitions have boosted revenues for the company and helped it out of the red. Additionally, its receiving authorization for Trobalt, a neuro drug taken for seizures, which it developed along with GlaxoSmithKline (GSK), as well as successful phase III trials for Onychomycosis, gives me a lot of comfort when looking at the company's future.

Like I said, operational and fundamental items are what I look for. Market diversification is critical, with developing markets flattening out. The recent acquisition (or intent thereof to be more precise) of the small cap Natur Produkt, the Russian drug maker, is a good example of what I like about this company. It is active where it needs to be, in the major drug opportunity markets around the world. Last year's acquisition of PharmaSwiss SA provides solid proof of this.

As identified by Apsara Biotech research, the strategy to pick up small biotech units of research at low prices has worked well for Valeant. What I don't like about the company is the unpredictability of non-operational items, which I guess does come with the policy of buying and selling companies to grow. In particular, interest expense has been growing, indicating the steady increase in debt, which increased almost 10 fold in fiscal 2010, and has doubled, give or take, in fiscal 2011.

I don't that too much debt is a problem for Valeant, particularly in this interest rate environment. In fact, with the large debt issues in fiscal 2011, it is safe to say that return on capital should improve substantially as the revenues from the acquisitions and agreements kick in.

Since November 2008, when the stock hit rock bottom at less than $8, the stock has appreciated nearly 7 times to under $55 recently. Apart from a dip of nearly 50% in July and August of 2011, the stock has appreciated consistently since November 2008. I believe this is the reason behind the whopping 100 times plus valuation multiple. Investors quite simply have confidence in the firm, as do I. The dip in July and August 2011 was speculative rather than being fundamentally driven. The fact that the stock has rebounded to its original pre-crash price should serve as proof of the sweetness in the pudding.

I believe Valeant is a great long term stock, although current pricing may raise a few eyebrows, justifiably so. I would not recommend Valeant to very defensive stock investors, particularly those that like to see regular cash flow. Dividends are dubious in the future, as the management's indication would suggest- the use of the words 'do not intend to pay dividends in the foreseeable future' is a clear indication of their intent to reinvest earnings in the growth of the company.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.