Is a $5 Billion Debt Reduction for Valeant Pharmaceuticals Intl Inc. Enough?

Valeant Pharmaceuticals Intl Inc. (TSX:VRX)(NYSE:VRX) is well on its way to meeting its goal for debt reduction, but is that good enough?

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Valeant Pharmaceuticals Intl Inc. (TSX:VRX)(NYSE:VRX) pledged to reduce its debt by $5 billion last year. In September, Valeant announced that it was selling its iNova business for $930 million, with $920 million of that going towards reducing its debt. The company originally planned to have the debt paid down by February 2018, but now Valeant says it is ahead of schedule, as the company also plans to sell its Obagi Medical Products division for $190 million later this year.

Investors responded positively to the news, and Valeant’s share price rose nearly 5% by the close of the day of the announcement.

What has the impact been on the company’s debt?

When the company made its pledge to reduce its debt in August 2016, Valeant had $31 billion in debt. As of its most recent quarter, the company had reduced that debt to less than $29 billion for a total reduction of $2.4 billion. The asset sales would reduce debt by another $1.1 billion.

In the most recent quarter, the company’s debt was more than seven times its equity, and a year ago it was less than six. Although the debt has gone down, the company’s equity has dropped by even more; as a result, that has caused the ratio to rise.

More importantly, the company’s EBITDA was 2.08 times its interest expense the past quarter, meaning Valeant has some breathing room over its covenants that require that interest coverage to be at least 1.5. However, all it takes is one bad quarter, and the company could be back in trouble.

Why this is no reason to celebrate

The company’s interest expense the last quarter was $456 million, and that is 2.6 times Valeant’s operating income and 20% of its revenue. A year ago, interest expenses took up only 19% of revenue as sales for the quarter were higher. Not only were the company’s sales down 8% from a year ago, but free cash flow has declined by 42% as well.

If the company is not able to find a way to grow its sales, it won’t matter that it has brought debt levels down, because if EBITDA numbers drop faster than interest expenses, Valeant will still be in danger of breaching its covenants.

With interest rates rising, this also accelerates the urgency for Valeant to get things under control. A reduction of $5 billion in debt is a good start, but that’s all it is — a start.

Should you buy Valeant today?

Despite its troubles, the stock is still trading at almost 1.6 times its book value and is not the bargain that you might expect it to be. In the past 12 months, the stock has declined 44%, and although it has increased 7% in the past month, this is a very high-risk investment. The company has earnings coming up in November, and unless it has a terrific quarter, it would be hard to justify investing in the stock.

With no growth and poor fundamentals, an investment in Valeant would be very risky and ideal only for speculators, not investors. There is a lot that is wrong with this company, and there are plenty of other stocks that would be better buys than Valeant.

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.

Fool contributor David Jagielski has no position in any stocks mentioned. Tom Gardner owns shares of Valeant Pharmaceuticals. The Motley Fool owns shares of Valeant Pharmaceuticals.

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