Valeant Pharmaceuticals (VRX) shares may be rallying roughly 12% in morning trading Monday, but steep interest expenses vs. the drugmaker's earnings could spell violations on agreements made with the companies creditors, analysts with Wells Fargo Securities say.
Based on interest expenses of $434 million for the second quarter vs. adjusted EBITDA of $1,087 million, Valeant's suggested interest coverage rate is now about 2.5x, far below the necessary 3x that Valeant must maintain on some of its debt.
"We believe investors and bondholders will question whether violation of covenants in 2017 is inevitable and if the reiteration of adjusted EBITDA guidance is realistic," the analysts led by David Maris added. EBITDA is a standard valuation metric that stands for earnings before, interest, taxes, depreciation and amortization.
As Real Money reported, covenant violations could be costly for shareholders, as they often mean making concessions with creditors, which have so far this year included Valeant agreeing in April to give holders of roughly $11 billion of its loans a temporary 1% interest rate hike, a fee equivalent of 0.5% of the loan's outstanding principal, as well as more stringent rules on Valeant's ability to make further acquisitions.
Valeant nevertheless managed to reiterate its full-year EBITDA guidance for the year with a range of $4.8 billion to $4.95 billion, which appears to have encouraged many that Valeant's recently appointed CEO Joseph Papa will be able to manage Valeant's high amount of debt -- which was acquired over the past several years to finance a string of Big Pharma acquisitions. Valeant also reiterated its expectations for 2016 sales of $9.9 billion to $10.1 billion, and adjusted earnings per share of $6.60 to $7.
"We believe some investors had been concerned that VRX would guide down this quarter, so reiterating the guidance was good to see and could come as a relief," BMO Capital markets analysts led by Gary Nachman wrote in a Tuesday note. "However, management will need to provide greater clarity as to how it expects to accelerate certain key parts of the U.S. business where there have been some challenges," he added. Valeant will especially need to show how it can boost profits with its recent partnership with Walgreens Boots (WBA) , which has so far been disappointing for Valeant, with low prices at the counter causing higher-than-expected losses for the drugmaker. (Walgreens stock is held in Jim Cramer's Action Alerts PLUS charitable trust.)
"What that means is every time a prescription goes out the door, we're taping dollar bills to that prescription," Papa had said on Valeant's first-quarter earnings call with analysts, his first after taking the helm of the firm. Valeant shares are down roughly 90% over the past 12 months, following a controversy surrounding price hikes on some of its drugs acquired over the past few years that led to the replacement of its CEO Michael Pearson with former Perrigo (PRGO) CEO Joseph Papa. That was followed by a board reshuffle and an SEC probe into Valeant's former partnership with mail-order pharmacy Philidor, in which Valeant acknowledged that $58 million worth of booked revenue was booked improperly.