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Let's play a quick game of "guess the pharmaceutical."
A growing pharma company goes on a major acquisition spree, taking on a lot of debt in the process. It then runs into problems that force it to drastically reduce its financial projections. Shares plunge in the aftermath.
If you guessed Valeant Pharmaceuticals (VRX +2.14%), then you're right. But you're also right if you answered Endo International (ENDP +0.00%), as both drug companies have gone down the same path.
Many investors are wondering whether either of these stocks might be worth buying on the cheap in hopes of a rebound. So let's see how Valeant and Endo stack up in order to decide which looks like the better buy right now.
The case for Valeant
To understand why Valeant might be a good investing choice, we first need to understand why the stock tanked -- and what the company is doing to resolve those underlying problems. Valeant's shares are down close to 90% over the past 12 months for two major reasons: an accounting scandal related to its relationship with Philidor Rx Services and intense public pressure to cut drug prices.
While Valeant at first defended its relationship with Philidor, Valeant soon terminated the partnership. It wound up restating earnings from 2014 and 2015 because of the way that it had recognized revenue in sales to Philidor. Delays in filing financial results put the company in hot water with bondholders, at least temporarily. However, Valeant announced in April that all accounting issues were resolved.
In response to public pressure to reduce prices for some of its high-cost drugs, Valeant announced plans to cut prices for its dermatological and ophthalmological products by 10% in December 2015. The company also said that it would slash the prices for certain branded products that had generic alternatives by an average of over 50%. In May 2016, Valeant announced expanded discounts for Nitropress and Isuprel -- between 10% and 40% based on hospital purchasing volume.
Along the way, Valeant replaced former CEO Michael Pearson with industry veteran Joseph Papa. The company subsequently made other personnel changes to its executive management team and board of directors.
Has Valeant's response been enough to put the company back on track? The jury's still out. A criminal investigation into Valeant's ties with Philidor is now underway. Bloomberg reported recently that some hospitals weren't seeing the promised discounts for Nitropress and Isuprel. Valeant issued a public response to the Bloomberg report, stating that some hospitals might not have realized the discounts yet because of timing.
While Valeant still hasn't escaped the shadow of these issues, it has several things going for it. Based on Valeant's confirmation of its full-year guidance in August, it seems that the company's revenue and earnings tailspin will stabilize. Valeant's cash flow also improved, which helps to service the large debt load. And the company has a stable of products and a solid pipeline that should drive growth in the years ahead.
The average price target among Wall Street analysts for Valeant is over 50% higher than the stock's current price. They apparently think the company will move past its current woes. Valeant's current valuation is really low, with the stock trading under four times forward earnings. If you agree with many of the analysts that better days are ahead, Valeant could be a huge winner for patient investors.
The case for Endo
Endo International's story isn't nearly as dramatic. There aren't any accounting scandals plaguing the company. Nevertheless, Endo's shares have fallen almost 70% over the past 12 months.
Many of Endo's woes are the result of competition. Voltaren Gel, a topical treatment for joint pain, faces a generic rival. Endo's generic drugs have experienced price erosion, partially caused by consolidation among generic-drug makers. Meanwhile, other products have experienced regulatory delays.
Endo's plan to meet these challenges primarily involves new product launches. The company is launching its own authorized generic version of Voltaren gel. Endo expects to have launched around 30 new products by the end of 2016, most of them in the second half of the year. The most significant of these new products include branded chronic pain drug Belbuca and generic versions of Seroquel XR and Zetia.
Like Valeant, Endo has recently replaced its CEO. Rajiv De Silva (who came to Endo from Valeant) stepped down, and Paul Campanelli took the helm. Campanelli was CEO of Par Pharmaceuticals, which was acquired by Endo in 2015. This game of musical chairs in the corner office enjoyed a positive reaction from the market: Shares of Endo jumped 15% when the news of Campanelli's promotion was announced on Sept. 23. Endo's stock had already begun to move upward, though, in late June.
The consensus among Wall Street analysts is that Endo's earnings will grow 9% next year. With a valuation of under five times forward earnings, Endo stock should have plenty of room to continue a comeback.
The better buy
Both Valeant and Endo are struggling with a cyclical downturn in generics. In my view, the better pick for investors is the company that is best positioned to emerge from the downturn with the wind at its back. I think that company is Endo.
Valeant is burdened with much higher debt than Endo. The company continues to face scrutiny over the Philidor relationship and its pricing policies. I like that Valeant brought Joseph Papa on board, but he has a tougher road ahead than Endo's new CEO, Paul Campanelli.
My take is that both of these stocks should be significantly higher five years from now. If I had to choose just one, though, I'd go with the company with less baggage. I'm in with Endo.
