In recent years, a Valeant Pharmaceuticals (NYSE:VRX) quarterly earnings report was grounds to call out sick from work, bury yourself under the blankets, and pray you'd still have money left when the day was complete. However, things changed during the previous quarter.
Back in August, the embattled drugmaker wound up reporting organic growth from both of its core operating segments, Bausch & Lomb and Salix Pharmaceuticals, and it stuck by its full-year EBITDA forecast of $3.6 billion to $3.75 billion. While far from anything worth crowing over, it wasn't a bad report. That's the first time investors could say such a thing in about two years.
The two figures you'll want to know in Valeant's Q3 earnings report
Tomorrow, Nov. 7, the company is set to release its third-quarter operating results before the opening bell. Needless to say, investors are hoping for another promising report where things aren't as bad as expected.
For the quarter, Wall Street is looking for Valeant to report about $2.2 billion in sales, which would be down by more than 10% from the prior-year quarter, to go with $0.90 in adjusted EPS. The company delivered $1.55 in adjusted EPS in third quarter of 2016. It's worth noting that Valeant has topped the Street's adjusted EPS expectations in two of the past three quarters after badly missing in all of the previous four quarters before that.
So, what should investors be on the lookout for in the upcoming Q3 report? My suggestion is to key in on two figures which will tell us in great detail what shape Valeant is really in.
Organic growth rates
The first thing you'll want to do is to dig beneath Valeant's many layers of one-time benefits, acquisitions, and divestitures so that we can get as close as possible to an apples-to-apples comparison on revenue performance. There are two separate categories you'll want to pay close attention to here.
First, take a look at how well its core Bausch & Lomb and Salix Pharmaceuticals segments performed on an organic, constant-currency basis. These operating segments are Valeant's bread and butter, so if they're growing, the company has at least one thing moving in the right direction. A mid-single-digit increase in sales from Bausch & Lomb, and a double-digit organic increase from Salix, would be an optimal performance in the third quarter.
Secondly, pay attention to the smaller segment contributors, which in recent quarters have been the biggest drag on Valeant's top-line results. Examining these figures may not be cut-and-dried due to divestments, but do your best to weed through the company's individual operating segments. In particular, the company's diversified products segment saw sales tumble in the second quarter, with big declines in dermatology and dentistry. While growth in these segments would be asking for a miracle at this point, we'd like to see an ebbing of the double-digit sales declines in non-core segments on an organic basis.
EBITDA-to-interest coverage ratio
Arguably an even bigger deal is the company's EBITDA-to-interest coverage ratio.
While it doesn't exactly roll off the tongue, this ratio that divides the company's quarterly EBITDA into its interest expenses for servicing its debt is what Valeant's secured lenders use to determine how safe their loans are. After ending the previous quarter with over $28 billion in debt, Valeant is required by its secured lenders to keep its EBITDA-to-interest coverage ratio above 1.5-to-1. In other words, it has to generate at least 1.5 times more in EBITDA than it spends in covering interest and fees associated with its debt. If the company were to breach this level, it would violate its debt covenants and potentially trigger a quicker repayment of its debt.
During the second quarter, Valeant's EBITDA-to-interest coverage ratio rose to 2.08-to-1 from 1.83-to-1 in the first quarter. This was the first time this ratio had improved in more than a year, which likely made the company's lenders breathe a sigh of relief. Nevertheless, Valeant's efforts to push out its maturity dates have resulted in the company accepting higher interest rates and fees in the process. That's why despite $3.6 billion less in debt than at its peak, the company is paying only marginally less in quarterly interest to service its debt.
The bad news for investors is that this is a calculation you'll need to make on your own by locating the company's quarterly EBITDA and interest expenses. If this ratio falls back below 2-to-1, that would be worrisome. However, if it at least maintains above the 2-to-1 level, or better yet improves, then investors may have something to crow about.
Mark your calendars, folks, because tomorrow is the big day.