Valeant Pharmaceuticals (NYSE:BHC) has had a miserable year. Shares of the embattled drugmaker are down nearly 80% year to date, and dating back to last summer its shares have shed more than 90%, which translates to more than $80 billion in lost market value. Whether this trend continues or reverses in the near term could very well depend on how well Valeant performed during the third quarter.
Valeant is expected to release its third-quarter earnings results before the market opens on Tuesday, Nov. 8, Election Day. Wall Street expects Valeant to report $2.5 billion in revenue and an adjusted profit of $1.76 per share. Yet, given the uncertainty surrounding the company's business model at the moment, no one is exactly sure what to expect.
Three figures in focus ahead of Valeant's Q3 report
The company's headline figures won't be the most in-focus figures when Valeant reports. Instead, smart investors are going to be focused on the following three figures.
The elephant in the room during Valeant's Q3 report will almost assuredly be its total debt levels.
Valeant ended the second quarter with $31 billion in debt after announcing the sale of three assets. It agreed to sell its European rights to brodalumab, its Synergetics USA OEM business, and its North American commercialization rights to Ruconest to Pharming Group. In return for these divestments Valeant netted $181 million, and it could be in line to receive $329 million more based on the achievement of specific approval and sales milestones.
Following the release of its Q2 report, Valeant's management team made it clear that its aim was to sell off its non-core assets, thus preserving its core growth drivers (Bausch & Lomb and Salix Pharmaceuticals). Valeant believes these non-core assets, which bring in about $2 billion annually and generate in the neighborhood of $725 million in annual EBITDA, could net the company up to $8 billion which can be used for debt reduction.
But there are a number of concerns surrounding Valeant's debt reduction strategy. Key to those concerns is that Valeant isn't selling from a position of strength. Its peers know the company is weighed down by its debt, and as such are unlikely to pay a premium or get into a bidding war over Valeant's non-core assets. It's possible that could change if Bausch & Lomb or Salix were put on the selling block, but if Valeant sells these core assets it could cripple its future growth prospects.
Wall Street is going to be very interested to see how successful Valeant was in reducing its overall debt and setting up future deals during Q3. If Valeant didn't do a great job of divesting non-core assets, it could be a rough day for shareholders.
EBITDA forecasts for 2016 (and perhaps 2017)
Along the same lines as the total debt figure, Wall Street and investors are going to be interested to see if Valeant sticks by its full-year EBITDA forecast and offers EBITDA guidance for the upcoming year.
In Valeant's second-quarter report, the company stuck by its EBITDA guidance of $4.8 billion to $4.95 billion for 2016. Though Wall Street cheered the move, Valeant's EBITDA through the first-half of 2016 was just $2.1 billion, leaving it well short of its forecasted EBITDA range on an extrapolated basis. Either Valeant was fully expecting a second-half rebound in its business operations, or management simply couldn't stomach the idea of reducing its EBITDA forecast for the third time in a six-month period. In a few days we'll figure out which is correct.
Valeant's EBITDA figure is of particular importance because of the debt covenants tied to its loans. Valeant's lenders had been more than willing to give the company loans for the purpose of drug and company acquisitions when its EBITDA covered its annual interest costs many times over. However, as Valeant's M&A dried up and its business model suffered, its EBITDA fell and its interest costs to service its debt rose. As a result, Valeant has had to renegotiate terms with its lenders twice this year to ease its EBITDA-to-interest cost coverage ratio, leading to more upfront fees and a higher interest rate. If the company's EBITDA-to-interest cost coverage ratio falls again in Q3, investors aren't going to be happy.
Dermatology segment sales
Lastly, all eyes are going to be on Valeant's dermatology operations. During the second quarter, Valeant reported that its dermatology sales, normally its flagship operating segment, fell 55% on a year-over-year basis to $208.4 million from $461.9 million in Q2 2015. This wasn't the first quarter, either, where sales of its dermatology products had plummeted.
Part of the blame could be traced to the public image damage done to Valeant's brands. Valeant has dug itself into a huge PR hole, and it takes time for consumers to forget price hikes on old therapies, such as the 525% and 212% respective increases for cardiovascular drugs Nitropress and Isuprel immediately following their purchase in February 2015.
The bigger issue, though, could be Valeant's comments in Q2 that its recently signed long-term drug distribution deal with Walgreens Boots Alliance was leading to more hiccups than anticipated. In certain instances, especially concerning its dermatology segment, Valeant's products have been selling at steep discounts that are below its costs. The deal also appears to substantially work in Walgreens' favor in that Valeant Is required to pay Walgreens a fee for offering its drugs regardless of whether or not the insurers reject a prescription in favor of a lower-priced substitute.
In Q3, Wall Street and investors are going to want to see clear signs of improvement and stabilization in the company's dermatology business, as well as get confirmation from Valeant's management team that its deal with Walgreens can benefit both parties over the long run. Another quarter where year-over-year dermatology sales plunge by 50%-plus could be disastrous to Valeant's stock.
Though Valeant remains an incredibly inexpensive stock on a forward earnings basis (assuming it sticks by its full-year EPS guidance issued in Q2), there are clear reasons why it's priced as "cheaply" as it is at the moment. My suggestion, as it's been for months, is for investors to remain on the sidelines and wait for clear evidence of stabilization in Valeant's business model, as well as an improvement in its crippling debt situation.