Why Key Analyst Still Sees Upside in Valeant Despite Downgrade

Valeant Pharmaceuticals International Inc. (NYSE: VRX) has been a lightning rod for attention of late, with the CEO taking medical leave and then coming back, controversial dealings with Philidor and a presidential hopeful attacking over “predatory pricing.” This company has been mired in controversy, and as a result its stock is down over 35% year to date and nearly 70% in just the past 52 weeks.

At this point, investors might be reaching for the parachute’s ripcord, or considering whether to buy in more, but one key analyst is taking a “Let’s see what happens” perspective, despite downgrading Valeant and slashing its price target.

Canaccord Genuity downgraded Valeant to a Hold rating from Buy related to the growing uncertainty surrounding its multitude of investigations, both internal and external. This downgrade is also based on the firm’s decreasing reliance on the company’s fundamentals (drug pricing, strained managed care relationships, patent challenges to Xifaxan). The price target of Valeant was lowered to $75 from $125 as well, still implying some upside for the stock in 2016.

The brokerage firm acknowledges that this downgrade has been a long time coming and, while it remains unconvinced that anything nefarious or fraudulent has gone on, the lack of transparency has eroded confidence in the positive recommendation. The delayed filing of Valeant’s 10-K, a potential earnings restatement, withdrawn 2016 financial guidance and the lack of clarity on the recently disclosed SEC investigation are all now overhangs on the stock with limited visibility to resolution.
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The return of Mike Pearson to the chief executive role is considered to be a positive, but Canaccord Genuity believes that it could take weeks or months to address the issues that have come up in his absence. Accordingly, when these concerns are resolved, the firm will revisit its fundamental analysts, but until then it will continue to have reduced confidence in Valeant’s outlook.

In the report, Canaccord Genuity detailed:

We believe that the discount rate in our valuation should reflect both the cost of capital and the risks inherent to the business. As new risks have popped up, credit spreads continue to widen (Valeant’s 10-year maturity bonds now yield 9.3%) and the cost of equity has increased (the stock is down ~71% over the past six months); we have therefore raised our discount rate to 15.8% in our DCF to reflect these uncertainties.

It concluded:

We continue to believe that Valeant is underpinned by a solid business with medium-term growth potential. Nonetheless, until Valeant addresses the near-term larger concerns, we expect the stock will continue to trade at a substantial discount to peers.

Shares of Valeant were trading up 4.2% at $68.17 on Wednesday, with a consensus analyst price target of $144.75 and a 52-week trading range of $59.87 to $263.81.