Questcor: A Possible 30% Upside, If Not More, Before 2014

| About: Mallinckrodt PLC (MNK)

The History & Overview:

I haven't taken a detailed look at Questcor Pharmaceuticals (QCOR) in quite a while, but the stock has recently piqued my interest with the release of fourth quarter earnings for 2012. The full press release can be found here.

My personal interest in Questcor began with the giant drop that the stock saw on September 19th, 2012. Another giant plunge in QCOR resulted in the writing of this article, which gave a general overview of the situation that had dropped QCOR shares by about 65% of their value in only a few trading sessions.

What triggered the selloff was an alteration to Aetna's reimbursement policy for H.P Acthar Gel. Acthar gel (repository corticotropin injection) was no longer covered for the treatment of infantile spasms, multiple sclerosis, and other indications related to the diagnosis and treatment of adrenocorticotropic hormone-related conditions.

After digging a bit deeper into the real implications of this lone policy shift, I realized quite quickly that QCOR had overreacted quite dramatically to this news. This was also being exacerbated by reports put out by third parties like Citron Research, which implied that Acthar sales were going to get destroyed by more reimbursement changes. The widely held notion that Acthar sales were in deep trouble suppressed QCOR for quite some time, dropping it as low as $17.25/share.

Smelling a bear raid, I began to publish more articles on the topic while Questcor battled the bears with a new 4% dividend and a $7 million expansion of its share buyback program. This one, which I published on Seeking Alpha, provided some details on the investment picture for QCOR. This included Questcor's statement that Aetna's policy change would have minimal impact on the financial performance of the company (with just 5% sales at risk).

QCOR recovered in October 2012, and continued to perform well. Healthcare insurers didn't take away more reimbursements on Acthar gel, and shorts began to get squeezed out of their positions. This takes us to Q4 2012 earnings, which were released on February 26th 2013.

Acthar Continues to be a Cash Cow

Despite Aetna's move against Acthar gel, the product saw record sales in Q4 2012, which resulted in a total of $160 million in Acthar sales for the last quarter 2012. This brought 2012 sales to a total of $509 million, representing 133% top-line growth in FY 2012 versus FY 2011. $509 million in revenues, including the $72 million that was subtracted as sales reserves, is very impressive for a 1.8 billion dollar company. This is especially true if you factor in the incredible top-line growth that Questcor is seeing.

Even more impressive in my book is the large amount of cash that the company generates from its growing pool of Acthar sales revenue. Questcor's expenses in 2012 totaled $184 million, which put the company's aggregated EBITDA profit margin at ~58%. At the root of this is low COGS (Cost of Goods Sold), which was a lowly 6% throughout 2012.

The company is flush with cash. I anticipate possible expansion of Questcor's already-great 3.22% dividend, and more buybacks.

Questcor is a $50 or $60 Stock Given Fair Valuation

Although QCOR has come a long way since the bear raid that occurred in September 2012, it has a long way to go to reach its old valuation just north of $50/share. Despite some new controversy that was introduced with Aetna's reimbursement change in late 2012, Questcor has been able to continue grow Acthar sales substantially. With the dividend, it's also giving another layer of value for shareholders who have supported the company throughout the recent mess.

If Questcor returns to its old valuation, current shareholders will gain 60%. Although I think QCOR is intrinsically worth $50-60 per share based on Questcor's sheer ability to generate cash, the market has not forgotten about the downright scary price action that we saw in September 2012. This lingering fear, as well as the uncertainty over Aetna's stance on Acthar gel, leads me to believe that QCOR will rally to $40/share in the short to medium term. This is my unofficial "price target".

Still, a rally to $40/share is substantial for shareholders who are interested in QCOR today. Given its current price, this would give investors a good chance at 30% in gains before 2014.

The Takeaway: QCOR is a Favorable Long

While I don't like giving price targets, I feel that my bullishness on QCOR is supported quite well by the company's financials, and I would be very surprised if the QCOR 26.00 April 2013 puts that I sold get exercised before expiration on April 20th. QCOR is undervalued, and I expect it to reach $40/share or more by 2014 as stated earlier.

Obviously it's important for any prospective shareholder to realize that every investment carries risk, and QCOR is no exception. Questcor's weakness is its lack of diversity, which means that its revenue is 100% exposed to Acthar Gel's prospects.

While this is a negative, it can also work to the favor of QCOR shareholders. Acthar is a blockbuster product, and continued success virtually guarantees appreciation of QCOR stock. The bearish argument against QCOR has yet to be realized, and Questcor's performance in the healthcare industry is implying the complete opposite.

Disclosure: I am long QCOR through April 26.00 put options. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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