Despite Woes, Valeant May Be Headed for a Rebound

The pharmaceutical giant has been under scrutiny for its pricing and distribution practices, but the company may offer a good investment opportunity for investors who can stomach some risk.
By Siddhi Bajaj ,

Valeant Pharmaceuticals International (VRX) , a former Wall Street darling, is a stock that investors are eager to dump right now.

So what happened to Valeant? How much of the stock's decline is attributable to the woes afflicting other pharma players that have also suffered a dismal 2015, and how much of it is a reaction to the company's relationship to a mail-order pharmacy and alleged questionable pricing? 

Should you buy Valeant? That depends on your risk tolerance. Below you'll find a deeper examination of the causes of the stock's nosedive and some thoughts on whether it will rebound.

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While the likes of AstraZeneca, GlaxoSmithKline, and Merck were heavily affected by the pharma sector downswing, others such as Gilead Sciences, Pfizer, and Vertex Pharmaceuticals have been under fire recently for positioning drugs at exorbitant prices.

Valeant's stock has been hit particularly hard, plunging more than 70% since early August when it reached a high of over $260 a share. Shares closed Tuesday at $70.65, down nearly $3 from the previous day. 

Federal prosecutors have been investigating Valeant's pricing, distribution and patient assistance programs. In one instance, Valeant marked up the price of a diabetes drug by 800%

Separately, Citron Research has published reports suggesting that the company had been part of a slew of questionnable transactions to boost its drug sales. At the center of the reports was Valeant's relationship with mail-order pharmacy Philidor. Philidor is alleged to have tried to ensure the purchase of Valeant drugs over lower-cost alternatives preferred by insurers.

Philidor was founded in 2013. But the origins of the California company are unclear. In late October, Valeant CEO J. Michael Pearson announced that his company would end its relationship with Philidor, and also that Philidor was closing. Under pressure from various reports, Valeant acknowledged that it owned an option in Philidor.  

Since then, the market has consistently punished the stock. But counter-intuitively, many credible analysts are now suggesting that the stock is a compelling bargain. They believe that the company's fundamentals are firmly in place.

So what should you do with Valeant? Bank of America's and Merrill Lynch have cited Valeant's diverse business mix, sticky and durable asset base and low product concentration risks as reasons to support the stock.

In a statement, Valeant's Pearson appeared determine to restore the public's trust in the company. Pearson acknowledged that Valeant's integrity was under scrutiny but added that "operating honestly and ethically is our first priority, and you have my absolute commitment that we will make it right."
At a call on Nov. 9, the company's management said that the discontinuation of Philidor would have an impact on the company's short-term prospects, but not a lasting effect on its dermatology and neurology businesses. Philidor accounted for 6.8% of Valeant's total third-quarter sales. Philidor sold largely drugs related to skin conditions, including a treatment for toenail fungus. The company said it was also actively assessing alternative access programs and expected them to be in place in about three months.

On the back of the latest update, Nomura's Shibani Malhotra, a five-star rated analyst on Tipranks.com, reiterated a "Buy" rating on the stock, but lowered the price target from $220 to $175. The new target account for "operational disruptions" as Valeant strove to rebuild its specialty pharmaceutical network and address pricing inconsistencies, "longer-term reputational impacts" and "potential employee attrition due to potential impacts to morale," Malhotra wrote.

JPMorgan Chase's Chris Schott also cut his price target on the stock from $265 to $225. The new price represents a more than 200% upside to the stock from current levels. The analyst suggested that the dermatology business would recover in 2016, forecasting $476 million in revenues from the unit in the fourth quarter and $2.1 billion in 2016. He sees revenue growing to $2.6 billion in 2020.

BMO Capital's Alex Arfaei seems bullish on Valeant's ability to overcome the controversy and also on the impact of Salix's portfolio of drugs on Valeant's earnings. The company acquired Salix in an $11 billion deal earlier this year after failed attempts to acquire Botox-maker Allergan.

Citron's report likens Valeant to disgraced and defunct Enron. However, New York University professor Aswath Damodaran suggested a different reading of the situation. While he didn't believe that the stock was undervalued, setting a target of $72.10, he considers the Valeant case differently from Enron. Damodaran's opinion reflects the company's valuable assets, unlike Enron which had no assets with tangible value when it was under scrutiny.

The verdict? If you're willing to shoulder some risk, Valeant makes a compelling contrarian comeback story. If you're risk averse, wait for clearer signs that Valeant has found its footing again.

That said, avoid this group of terrible stocks. They will never regain their footing. The problem is that many of them are widely held in retirement portfolios. For a full report on 29 dangerous stocks you should dump now, click here.

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

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