Overwhelmingly, the investor mood surrounding Valeant Pharmaceuticals Intl Inc (NYSE:VRX) is negative. Much like Sears Holdings Corp (NASDAQ:SHLD), you don’t need to be told these are companies in serious distress. VRX stock has lost an incredible 82% of its value over the past year, while SHLD isn’t too far behind at 54%.
Of course, Eddie Lampert has a plan that will finally resurrect the once-great retailer to its rightful place atop the retail industry.
Like Sears, Valeant has begun to sell off assets to pay down its $30 billion in debt. Eventually, emptying your boat brings you to the sad realization that you’ve got nothing left to throw overboard except yourself and that’s never the outcome you’re looking for.
I have no idea whether Valeant Pharmaceuticals can make a comeback, but what I do know by looking at its Altman Z-Score is that the odds of failure through insolvency are pretty darn high; perhaps higher than Sears, which has been on its deathbed for years.
Valeant Pharmaceuticals’ Altman Z-Score
Most of the calculations above are readily available.
- Working capital is simply Valeant’s total current assets minus its total current liabilities as of Q3 2016.
- Total assets, total liabilities and retained earnings (accumulated deficit) can also be found in VRX’s balance sheet from Q3 2016.
- For EBITDA, I’ve used the 2017 EBITDA projection from a Seeking Alpha article that appears well thought out and coherently argued despite the author’s long position. (That’s what makes the markets interesting — there’s always a different opinion on the other side of the trade.)
- Market cap is as of Feb. 14.
- Net sales are based on the analyst 2018 estimate.
Generally, you want your companies to have an Altman Z-Score of at least 1.8, but preferably above 3.0, which suggests it can withstand an unexpected financial hit to its business.
Nobody really knows what the future holds for Valeant and VRX stock. While $4 billion in projected EBITDA looks nice on paper, the reality is that Valeant Pharmaceuticals will use close to $2 billion to pay the interest on its $30 billion in debt in 2016. It will generate approximately the same amount of operating cash flow, leaving it with little to repay that massive amount of debt.
This creates a vicious cycle where assets are sold to pay down debt, which reduces cash flow and its ability to repay the remaining debt.
Again, I realize this is not new information, but anyone who’s seriously considering going long on VRX stock needs to think long and hard about why they’re doing so because a 0.47 Altman Z-Score is life threatening.
Sears’ Altman Z-Score
Over the past 10 years, Sears’ Altman Z-Score has been as high as 5.22 and as low as 1.01 where it sits today. In the decade that has passed, SHLD stock has generated a negative annual total return of 18.6%, reducing a $10,000 investment in 2007 to less than $1,300 today. By comparison, the same investment in the S&P 500 would we worth slightly more than $20,000.
Is any of this sinking in?
Bottom Line on VRX Stock
Valeant stock is in a worse position than Sears and it’s only at the beginning of its painful process to right the ship. It’s going to get a heck of a lot worse before it gets better.
For those investors who have short-term memories, let me bring you back to March 2016 when then-CEO Michael Pearson sent a memo to staff reassuring them that Valeant wouldn’t go bankrupt.
How many times has a general manager or owner of a sports team said good things about a coach going through a losing season, only to turn around shortly thereafter and fire him or her? A lot.
As others have said before, VRX stock is a speculative bet — at best — and a complete waste of money, at worst. Longs can talk all they want about all the great drugs in the pipeline but Valeant Pharmaceuticals’ Altman Z-Score tells it all.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.