Smoke Today, Fire Tomorrow?

One of the things that can ruin a company is financial risk. Valeant Pharmaceuticals is loaded with it and nobody seems to care.

| More on:
The Motley Fool

Making a positive contribution to the S&P/TSX Composite on this fine March day is Valeant Pharmaceuticals (TSX:VRX,NYSE:VRX).  Valeant is no stranger to the list of positive contributors as the stock has increased by 19% thus far in 2013 and is up 31% over the past year.  Valeant shareholders are surely beaming over these solid returns.  However, all shareholders, current and prospective, should be aware of the financial risk embedded within this name.


Valeant, in its present form, was born out of a merger between it and Biovail in 2010.  The combined entity is a specialty pharmaceutical company focused on skin care products, neurology medicines, and growing its presence in international markets.  Its product portfolio includes branded, generic, and over-the-counter items.

Since the merger, the new Valeant has been, to say the least, rather acquisitive.  During 2011 and 2012 the company spent close to $6 billion on numerous acquisitions.  To put this figure into context, this was a company that exited 2010 with a market cap of about $7 billion.  The Valeant shopping spree has included everything from individual products to entire companies.


The company generated a total of $1.1 billion in free cash over the two-year 2011/12 period.  Good, but not $6 billion of acquisitions good.  The shopping spree was largely financed with debt, as equity issuance has been negligible.  In fact, management was so enamoured with acquisitions, $850 million (net) of stock has been bought back.

Total debt has increased from $3.6 billion at the end of 2010 to $11 billion (!!!) at the end of 2012.  This has left Valeant’s balance sheet in a rather precarious state.  As the table below indicates, debt related ratios have clearly deteriorated.



Total Debt



Total Debt/Equity



Interest Coverage






Z Score



Source:  Capital IQ

The Z-Score is the only metric on the table that shows an improvement.  This ratio has a reasonable track record of predicting insolvency before it occurs.  The problem with the improvement that Valeant has shown is that both Z-scores represent a firm in financial distress.  Anything below 1.81 qualifies as “distressed”.

Cause for concern

Along with all of this debt, the company has taken on a pile of intangible assets.  Goodwill and intangibles have gone from 1.9x book value to 3.9x.  A couple of years from now, if Valeant finds that it overpaid for some of its acquisitions and is forced to write-down these intangible assets, its net worth could be completely wiped out.

On the bright side, at least this debt has been added in a historically low rate environment.  If however they don’t begin chipping away at this massive pile, as they have to start rolling over the debt in a potentially higher rate environment, interest charges are going to spiral to potentially unaffordable levels.

The Foolish Bottom Line

Analysts love Valeant with 10 of the 17 that cover it giving it a coveted “strong buy”.  2 others have it ranked as a slightly less prestigious “buy”.  What sell side firm would be crazy enough not to embrace such an acquisitive, fee generating entity?

Given its short-term performance, investors clearly love it as well.  I’m sure you’d be hard pressed to find a growth oriented Canadian portfolio manager that doesn’t own this stock.

This debt situation is a clear red flag in my mind.  Valeant is loaded with financial risk, something that can bring a company to its knees.  Stacked on top is the execution risk that an extended series of acquisitions brings.  There is smoke associated with this story – time will tell if it’s attributed to a red-hot stock or an exploding business model.

Follow us on Twitter and Facebook for the latest in Foolish investing.

Fool contributor Iain Butler does not own shares in any of the companies mentioned in this report at this time.  The Motley Fool has no positions in the stocks mentioned above.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

More on Investing


2 Great REITs That Won’t Stay Cheap Forever

First Capital REIT (TSX:FCR.UN) and Automotive Properties REIT (TSX:APR.UN) are cheap real estate plays for yield-seeking Canadian investors.

Read more »

shopping online, e-commerce
Tech Stocks

Young Investors: Shopify (TSX:SHOP) Stock May Finally Be Worth Buying

Shopify (TSX:SHOP)(NYSE:SHOP) stock is attempting to stage a bottom, but should investors be buyers amid the market chaos?

Read more »

stock analysis

3 Ideal Stocks for Your Short-Term TFSA Growth Goals

Depending on what your short-term growth goals are, you can choose from the diverse pool of growth stocks, including linear…

Read more »

Human Hand Placing A Coin On Increasing Coin Stacks In Front Of House

1 of the Cheapest REITs in Canada Looks Poised to Soar

H&R REIT (TSX:HR.UN) has become way too cheap to ignore for passive-income seekers who want a great deal from the…

Read more »

Early retirement handwritten in a note

TFSA Investors: 3 Top TSX Stocks to Buy Now for Early Retirement

Plan an early retirement by maximizing your TFSA and investing in solid stocks like CN Rail (TSX:CNR)(NYSE:CNI) for growth.

Read more »

Tech Stocks

How to Easily Turn a $25,000 RRSP Into $250,000

You can hold quality growth stocks such as Shopify in your RRSP and benefit from market-beating gains in the long…

Read more »

Retirement plan
Dividend Stocks

3 Retirement Stocks to Buy in Your 20s

A retirement stock is not necessarily something you buy when you retire. It also includes a broad spectrum of stocks…

Read more »

Dividend Stocks

Dividend Earners: Stay Invested in 2 Low-Volatility Stocks

Dividend earners can stay invested, despite the extreme market volatility provided they shift to two low-volatility stocks.

Read more »