4 Key Takeaways From Valeant Pharmaceuticals' 4th Quarter
- Valeant Pharmaceuticals fell 20 percent last week after markets misinterpreted its fourth-quarter results.
- Stock is now 28 percent below my $19 price target.
- Four considerations: Lower EBITDA in 2018, higher short-interest, near-term headwinds and fair value.
Shares of Valeant Pharmaceuticals (VRX) closed at a price close to 30 percent below my $19 fair value assessment. On the surface, fourth-quarter revenue fell 10 percent while Bausch + Lomb sales fell. Though management forecasts revenue of over $11 billion solely on one product like VYZULTA, it still guided 2018 revenue by below that. The seasonal slowdown in the current first quarter also spooked investors. Now that the stock is at a 20 percent discount on the week and down 28 percent in 2018, what is the next move on VRX stock? Investors ultimately must consider four takeaways following Valeant's quarterly earnings before deciding what to do.
1) Lower EBITDA Expected
You may find Seeking Alpha’s Q4 earnings summary and 2018 guidance here. Every key reporting metric, from revenue to EBITDA to earnings, are all down. Investors headed for the exit when management said it would continue to make debt reduction a priority over returning free cash flow to shareholders. Further, the company lowered its $500 million free cash flow expectations down to the low-$400 million per quarter. This is due to higher capital expenditure requirements and other cash costs and investments it will make for the short-term.
While this is a disappointment for speculators hoping for a quick turnaround, the short-term investments are needed to support Valeant’s long-term plans. It will use every jump in free cash flow during any quarter to pay down its debt. Since the end of Q1/2016, Valeant cut its debt by over $6.7 billion. It still has $25.5 billion in debt. While its next maturities are not until 2020, the company wants to continue lowering debt to more manageable levels.
The U.S. Fed’s forecast for raising interest rates at least four times this year, up from three, suggests that Valeant has a higher urgency to having a lower debt/equity profile. It must simultaneously support the launch and growth of the “significant seven” key products in 2018. These products include:
Vyzulta Lumify Siliq Duobrii (IDP-118) Jemdel
Source: Valeant Pharmaceuticals
2) Short Interest Surges
Bearish bets on VRX stock jumped in February, as the short percent rose from 7.5% (2 million shares) in early February to 13 percent on March 2.
Unsurprisingly, low-ranked (per Tipranks) analysts weighed in to add their bearish sentiment in the last week following the Q4 results. David Amsellem of Piper Jaffray has a 41 percent success rate and a negative 4.3 percent average return in the last two years. He set a $10 price target on Valeant. David Maris of Wells Fargo, rated with a one-star, is right 40 percent of the time and has a negative 2.4 percent return over the same period.
David Steinberg of Jeffries has a 4.5-star rating, a “buy” rating on VRX stock and a price target of $19. This is in the ballpark of my previous PT at a time when Valeant was trading in the $18 - $24 range. Steinberg has a 49% success rate but his average return on calls is 30.4 percent.
Valeant's stock in the last month is shown below. Even Allergan (AGN), which sold its generics unit to Teva Pharmaceuticals (TEVA), fell. Celgene (CELG), which is cash-rich, fell 10.5 percent after the company unexpected fumbled with its ozanimod application with the FDA.
3) Near-term Headwinds
Bears will cite the lower adjusted EBITDA in 2018 as a negative development for Valeant. The reason for lower earnings is simple: management must invest in the business to support the long-term growth drivers. On the conference call, the company said:
we expect to invest more in R&D in 2018 than 2017. The point of this story is that our objective is not to maximize adjusted EBITDA in 2018. It's to ensure that we support each of o ur go-forward businesses with appropriate resources to drive the best long-term outcomes.
Source: SA Transcript
Siliq, which targets patients suffering Psoriasis and VYZULTA, which treats patients with glaucoma, are examples of potential blockbuster drugs that need plenty of marketing and R&D investments. Instead of giving the product away through low pricing and rebates, Valeant is instead investing with its partners in the health care community and through distribution channels. As awareness builds, sales will grow, too.
Fortunately, Valeant’s low 13 percent effective tax rate and tax reform will give the company more cash from earnings. This will add to the company’s adjusted revenue growth of 3 percent to five percent. Adjusted EBITDA will grow in the range of 1 percent to 6 percent:
Source: Valeant Pharmaceuticals
4) Price Target and Fair Value
Plugging in Valeant’s adjusted revenue and EBITDA base values, investors may use the 5-Year DCF Revenue Exit model. The philosophy behind a DCF analysis is that the fair value a company is equal to the future cash flows of the company, discounted back to present value (per finbox.io).
Forecast revenue growing just 3 percent starting in FY2019 but EBITDA of 38 percent as a percent of revenue:
At an average exit multiple of 3.9x, Valeant’s fair value is still around $19:
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This article was written by
Individual investor with three decades of experience who runs DIY Value Investing.Affiliate partner at StockRover.
Chris (email@example.com) is an Hon B.Sc graduate (with distinction) in Science and Economics. He holds a PMP (Project Management Professional) designation.
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