Valeant Pharmaceuticals (NYSE:BHC) is notorious for its drug price gouging scandal a few years ago, an incident that caused the stock to tank and public opinion of the company plummeting to hit rock bottom. In the past few years, the company has replaced their CEO and cobbled together a turnaround plan, but many analysts and investors are still skeptical.

In this clip from Industry Focus: Healthcare, the cast looks at Valeant's most recent earnings report, which sent the stock up 17%, and what the company's future looks like. Listen in to find out the most important numbers to look at to see how the company is doing, why Valeant's stock price shifts so much after every earnings report, how it did this quarter and what that says about the company's long-term potential, what investors should know about buying this company on the turnaround story today, and more.

A full transcript follows the video.

This video was recorded on Nov. 8, 2017.

Kristine Harjes: As promised, our second topic of the day is Valeant, another stock that just reported earnings. In contrast to Keryx, which sank about 17% earlier this week, Valeant soared 17%. They're still well below where they once were. Today's price is about 95% below their 2016 peak. They have a new CEO, new-ish, and he's trying to turn the stock around. And it seems like he might be starting to get some positive momentum.

Todd Campbell: It's all a matter of traction with this company. We've talked about Valeant in the past. Maybe it would be helpful for some of our new listeners who aren't as familiar with the story to give a little bit of background on the company. I think, to sum it up, what we could say is this is a relatively problem stock, one of the most love-to-hate stocks on Wall Street over the course of the last couple of years. The former management team had a business strategy that was highly acquisitive: We're going to go out, we're going to acquire all sorts of other companies, we don't care how much it costs us, how much debt we have to take on, that's what we're going to get our growth from. As a result, we're not going to spend a lot of money on research and development to develop our own drugs in house. We're just going to focus on acquisitions, acquisitions, acquisitions. And then we're going to drive growth from those acquisitions by using a specialty pharmacy that has since come under scrutiny and been shuttered for some, we'll call it improper marketing techniques. So, that was a big headwind for a company. You have the fallout from that, where management got shaken up, and you got a new CEO come into the company about 18 months ago. And you've also got a steep drop off in sales stemming from this whole problem that emerged in 2015 and 2016 as well.

I think the big issue for Valeant shareholders today is, we know it was $250-something a share back at the peak, but it was also less than $10 at the low. Where is it going to go from here? That I think really depends on how well this company orchestrates on its turnaround plan. How quickly can they get the debt levels under control, and then shore up sales to get to a point where they're actually delivering growth instead of contraction?

Harjes: And that's a bit of a catch-22. They're really caught in between a rock and a hard place. On one hand, they need to make more money to generate more revenue to cover their interest expense. But on the other hand, they kind of need to sell off some assets just so that they can lower their debt levels pretty quickly and get rid of that interest expense again. But if you sell off your assets, you don't grow revenue. And that also makes analyzing their quarterly statements extremely interesting and kind of difficult, because you can't just compare year-over-year on a GAAP basis, which is that number that you see reported as the accounting number. You kind of have to take these necessary adjustments to it and look at the non-GAAP numbers to see what's really going on with the growth here. If they report one thing, but that's because they have, say, one big tax advantage, and they sold off this other huge unit, that doesn't really give you a clear picture of what's going on.

So, what you really want to look at here is what happened on constant currency and excluding divestitures and discontinuations. That's how you can really get a better sense of how they're doing. In particular, it's really important to look at this with their bread-and-butter segments, which is the Bausch & Lomb segment, and the Salix segment. These are two places where they generate 77% of their business. So, that's really where you need to look for organic growth. And thankfully, they have not sold off those entire units yet -- there was speculation that they might be considering a sale of those units. But, again, to do that would really hamper their growth going forward.

So, you look at some of the constant numbers. The Bausch & Lomb unit grew their revenue by 2% constant currency. Or, if you take even more exclusions -- this is, again, the divestitures and the discontinuations -- their sales increased 6%. That's not gangbusters sales growth, but that's solid. Salix, meanwhile, had organic growth also of 6%.

Campbell: Yeah. So, you have those two parts of its business that are performing at least stable to slightly up. If you look at those businesses, I think Bausch & Lomb was up 1% if you include all of the junk. Salix was up 3%. That's not barn-burning by any stretch, but at the same time, it's pretty darn good when you look at the other parts of its business, which is the branded Rx business generally and the U.S. diversified products business, both of which saw sales drop off pretty dramatically both because of the divestitures and also because of some competitive threats of new drug launches and pricing renegotiations and like.

So, overall, Valeant reported $2.2 billion in revenue. That was down 10.5% on an all-included basis. Or, if you just want to look at organic, it was down 4%, which isn't horrible, if you look at it on the organic, the ex-currency and all that basis. Bausch & Lomb and Salix did really well. However, branded Rx fell overall, down 17% to $633 million, and U.S. diversified products fell 29% to $332 million. So, those two smaller pieces of the business really are a big drag, and they are going to have to find some footing for those two businesses if they hope to get to a point in late 2018 or 2019 to start putting up top line growth once all the junk gets anniversaried, and you have cleaner year-over-year comparisons to be looking at.

Harjes: Yeah. One other metric to really keep a close eye on is the EBITDA-to-interest-coverage ratio, which essentially just means, how safe are the loans? If you're somebody who had lent Valeant a bunch of money, you want to make sure that you're going to get paid back, so you can put in these stipulations saying, "You need to meet my demands, otherwise there are going to be repercussions." So, with this, Valeant needs to make a certain amount of money as compared to how much they're paying in interest in order to not violate these debt covenants and potentially trigger stuff like a quicker required repayment. They have made some progress on this, but not really a ton. Their interest expense is not dropping that quickly. Fortunately, I guess -- I do want to pull out some good news to try to highlight why the stock was up -- they don't have any long-term maturities until 2020. They have slightly less debt. They ended the quarter with $27.6 [billion], this is down from the end of Q2, they had $28.2 [billion]. They have pretty steady levels of cash from quarter to quarter. And right now, that interest coverage ratio that I talked about has gone up to 2.08, which is a good thing. You want that to be well above the required 1.5.

Campbell: Yeah. To back up slightly, one of the reasons that so many people hated this stock and were willing to short this stock is, they thought the creditors were going to put them into default for violating the covenants. I think originally, it was a 3-to-1 ratio, they renegotiated it down to a 2-to-1 ratio, they renegotiated that to 1.5-to-1 ratio. It was expensive to renegotiate that, and that's why you've seen debt fall by $6 billion, but the interest expense hasn't really moved that much, because, of course, the terms have changed for the debt. That being said, they are making headway.

And if you look at where we are on those EBITDA to interest coverage trends, we're well above the 1.5 on the adjusted basis and above 2, and as long as there's nothing that's materially crazy that happens for this company over the course of the next year, without having any long-term maturities, it's one of those situations where you look at it and say, OK, maybe we go from valuing this stock as a stock or company that's at risk of going into bankruptcy because of creditors. Instead, say, it's a troubled turnaround story that's in the early innings of getting itself back on the right path. If you're an investor, that changes your whole approach to the stock, because now you're not saying, "Am I hoping for a bankruptcy, or am I hoping for slow growth over time?" It may not be worth being short the stock anymore if that's the case. And I think that's really what we're seeing here. A lot of investors who held a significant number of shares short are saying, you know what, I think the story is changing a little bit here, and as a result, when the stock sells off a little bit, I'm going to cover some. So, every time that the stock has sold off in the last two quarters, buyers have come back in and driven it back up. And I think a lot of that is due to reduction in the short interest.

Harjes: Oh, yeah, I absolutely agree. As defaulting on their debt becomes less and less likely, the shorts are exiting their positions. Remember, with shorting a stock, your potential losses are infinite, so a lot of shorts can be kind of skittish. If it looks like the company might be about to break out, they want to get out of there. They don't want to be caught having to pay up to who knows how much.

Campbell: Yeah. We're an investing show, so every investor listening right now is thinking: Do I go out and buy Valeant? It's very hard to make the argument that Valeant is the best stock in healthcare, that you need to run out and add this to your portfolio. I think it's a changing story. I wouldn't be short it, and frankly, I wouldn't be long it. I think it still needs to prove itself. We need to get some of these junk quarters behind us so that we can actually get some clean numbers and see where this company is heading once we get late into 2018 and 2019. Now, the stock could go up significantly, it could bounce significantly in the interim. Who knows. We don't know. But, I just don't feel confident enough one way or the other to recommend that investors go out and either continue selling it short, or go out and add it to their portfolios at this price.

Harjes: Yeah, absolutely. And when I look at their new CEO, Joseph Papa, I think about him the same way that I think about Uber's new CEO. He came into this business when it was at such a low point that's there's really not a whole lot he can lose. Either this stock doesn't end up doing very well, it can't ever get back to its former days of glory, and people are like, "Eh, you know, he tried, but what are you going to do with that pile of garbage?" Or, you end up being able to turn it around -- and he said it himself, it's the turnaround opportunity of a lifetime -- at which point, the guy is a hero.

Kristine Harjes has no position in any of the stocks mentioned. Todd Campbell has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Valeant Pharmaceuticals. The Motley Fool has a disclosure policy.