Valeant is taking over profitable market niches that its mega-cap competitors ignore

THURSDAY, OCTOBER 31, 2013

Valeant Pharmaceuticals: Stock Could Climb 42%

By TERESA RIVAS | MORE ARTICLES BY AUTHOR

Valeant is taking over profitable market niches that its mega-cap competitors ignore.

Hefty research and development expenses, patent cliffs, and slow growth levels are well-known knocks against big pharmaceutical companies. They’re all problems that Valeant Pharmaceuticals International (ticker: VRX) doesn’t have. Over the past five years CEO Michael Pearson has transformed the specialty pharmaceutical company with a series of savvy acquisitions, diversifying its product mix to lower patent and approval risk, and expanding in fast-growing emerging markets. Yet investors can still buy the stock for about 12 times forward earnings—on par or cheaper than other big drug makers.“We first bought Valeant in early June and we’re still buying it,” says John Maloney, chief executive of M&R Capital Management. “They have a very broad product portfolio with steady organic growth and limited risk: Their biggest product is only 3% of revenue, so patent cliffs aren’t a problem, and 75% of their revenues don’t involve government reimbursement, [which can] change over time.”

At a Glance

Valeant Pharmaceuticals International(VRX)

 

Stock Price:	$105.72
52-Week High:	$115.40
52-Week Low:	$52.50
Market Value:	$39 billion
Est. 2013 EPS:	$6.13
Fwd P/E:	12.2
Est. Long-Term EPS Growth:*	17%
Est. (’13/’12) EPS Growth:	35.90%
Revenue (trailing 12 months):	$4 billion
Dividend Yield:	None
CEO:	Michael Pearson
Headquarters:	West Laval, Quebec, Canada

* Based on analyst estimates looking ahead three to five years.
Sources: Barron’s, Thomson Reuters, Yahoo! Finance

Maloney sees the company earning around $11.50 in 2016, even without any future acquisitions. “Just using the forward earnings multiple now, that would get you a $150 stock in two years.” Shares closed Thursday at $105.72.

Goldman Sachs is also impressed. Analyst Gary Nachman recently added the company to his Conviction Buy List with a 12-month price target of $130, or 13.7 times his 2014 adjusted earnings-per-share estimate of $9.47. “Even without future M&A, we expect that Valeant will continue to be a ‘beat and raise’ story, and that could be largely driven by synergies from recent deals coming in ahead of expectations.”

The stock shed 2.5% Thursday in response to third-quarter earnings—Valeant reported a loss of $973.2 million, reflecting restructuring and legal charges. Yet the dip looks like a buying opportunity, as the major charges were one-time in nature, and the company’s EPS otherwise exceeded expectations. Costs surrounding its $8.7 billion acquisition of eye-care firm Bausch + Lomb are nonrecurring, and Valeant increased its synergies estimate for the deal. In addition, its $142.5 million litigation settlement with Anacor Pharmaceuticals (ANAC) was smaller than that company had expected, and does not include ongoing royalty payments or an injunction to stall Valeant’s product launches.

Valeant closed the Bausch + Lomb deal in August, and estimates $850 million in cost reductions. While that deal was bigger than most, it typifies Pearson’s strategy of making accretive acquisitions and targeting products with healthy margins in areas that have been neglected by bigger pharmaceutical companies, from dermatology to ophthalmology and branded generics. This rollup strategy has allowed it to boost its earnings power and diversify its revenue stream.

BMO Capital Markets analyst Alex Arfaei says that a recent decision by Merck (MRK) to refocus on its top 10 geographic markets is a positive for Valeant. “The businesses that Merck is going to divest are in Valeant’s markets,” he says. “Not only will [Valeant] have less competition, but at least some products could be available for purchase.”

Arfaei isn’t concerned about the debt that Valeant has accrued during its purchases. Valeant has just under $11 billion in debt now, against a little more than $2.5 billion in cash. He says the company generates an impressive amount of cash that allows it to bring down leverage quickly and that its cost structure—lower taxes and R&D expenses—means that “every dollar of revenue is more profitable for Valeant than Merck,” so it can afford to make bids for upcoming opportunities.

Valeant’s U.S. prescription dermatology business is one of its best acquisition success stories—it moved from being the 11th largest player in 2008 to the market leader, with sales 50% higher than its closest competitor. Its branded generics business, in which it creates brand names for generic drugs that can still sell at reduced price points, is growing rapidly in Latin America and Eastern Europe.

Insiders appear confident about the company’s prospects: Pearson owns nearly 2% of the shares outstanding, and during a five-week period beginning in mid-August, five insiders purchased more than $6.7 million in stock. The purchases came even as the stock was at multiyear highs and the health-care sector in general was slightly skewed toward executive selling, according to InsiderScore, which classified the moves as “an unusually aggressive buying streak.”

To be sure, it’s not a foolproof stock. Like any drug company, Valeant could suffer if drugs in its pipeline aren’t approved by the Food and Drug Administration, and its bevy of end markets means that foreign exchange can take a bite out of the bottom line. Many investors may be put off by the debt load.

Still, Valeant is aiming to bring down its debt meaningfully in the next few years, helped by its strong cash position. The company is so well diversified that bad news for one of its products doesn’t spell disaster.

“We think there’s a lot of upside left,” says M&R Capital’s Maloney.

Full Disclosure

• BMO Capital Markets analyst Alex Arfaei has a Buy rating and $123 price target on Valeant Pharmaceuticals International.

• Goldman Sachs analyst Gary Nachman has a Buy rating and $130 price target on Valeant Pharmaceuticals International.

• M&R Capital owned 83,405 shares of Valeant Pharmaceuticals International as of June 30, 2013.