The Not-So-Subtle Reason Behind Valeant Pharmaceuticals' 30% Rise in May

A better-than-expected earnings report lights a fire under optimists -- but if they aren't careful, they could get burned.

Sean Williams
Sean Williams
Jun 7, 2017 at 4:42PM
Health Care

What happened

Shares of Valeant Pharmaceuticals (NYSE:BHC), an embattled drugmaker known for growing by acquisition and raising prices on mature therapies, exploded 30% higher in May, according to data from S&P Global Market Intelligence. The reason for the surge in Valeant's share price can be traced to its better-than-expected first-quarter earnings release on May 9.

So what

There were a number of optimistic aspects of Valeant's earnings report that got Wall Street and shareholders excited.  For starters, a $908 million tax benefit allowed the company to record a quarterly profit for the first time in six quarters. In addition, the company's core Bausch & Lomb operating segment showed 4% constant currency growth, a nice improvement from the 1% year-over-year sales decline reported during the sequential fourth quarter.

An investor in a suit clicking on the "quarterly report" tab on his digital screen.

Image source: Getty Images.

However, the stars of Valeant's earnings report were its debt reduction and EBITDA guidance.

As of the end of Q1, Valeant reported $28.54 billion in debt, which is down well over $3 billion from where it stood at its peak. The company appears to have used all, or a bulk of its proceeds, from the sale of three medicated skincare products to L'Oreal to help reduce its debt by $1.3 billion from the sequential fourth quarter, with cash on hand and organic cash flow-based pay down playing a lesser role. CEO Joe Papa had placed a target of $5 billion in total debt reduction by mid-2018, and the company has yet to close on its $820 million sale of Dendreon's assets to China's Sanpower. It appears well on its way to hitting that target.

The other catalyst came from Valeant lifting the low and high end of its EBITDA forecast by $50 million to a fresh range of $3.6 billion to $3.75 billion. Valeant's secured lenders and investors are keeping a close eye on the company's EBITDA, as it helps determine whether the company remains in compliance with its debt covenants.

Now what

Though Valeant Pharmaceuticals' earnings report was less of a train wreck than in previous quarters, there were still plenty of things to be concerned about. For example, the company would have lost money, once again, if not for a one-time tax benefit. Similarly, while its Bausch & Lomb business improved, its Branded Rx operations, which are its other core segment, were still abysmal, with sales declining 9% year over year.

A frustrated stock trader clasping his head.

Image source: Getty Images.

The two factors that were particularly worrisome in Valeant's earnings report are the same figures that optimists referenced when pushing Valeant higher: its debt and EBITDA. 

Although Valeant was able to lower its debt by $1.3 billion from the sequential fourth quarter, practically none of this was due to organic pay-down. Valeant appears almost entirely reliant on the sale of its non-core assets to lower its debt, and there's absolutely no guarantee it can secure a reasonable price for its assets given that its peers are fully aware of its perilous situation.

The other issue I have is with the EBITDA guidance itself. Not only does Valeant's EBITDA guidance include its Dendreon assets, which will soon be removed from the equation, but its EBITDA-to-interest coverage ratio (i.e., what it pays to service its debt) also dropped to another all-time low of 1.83-to-1. Valeant could still potentially default on its debt even after having pushed its maturities out.

Despite being a selection of The Motley Fool's Everlasting Portfolio, this Fool would suggest investors stay as far away as possible from Valeant.