There are thousands of stocks that are unlike Valeant Pharmaceuticals International Inc., with its uniquely stunning rise and shocking fall. And there are two, in particular, that we might suggest are very, very dissimilar.
One, Gilead Sciences Inc., illustrates how a drug company can embrace research and development to build on its existing portfolio and create a long-lasting business that generates ample cash – and is cheap, to boot, making it appealing to value investors. The other, Danaher Corp., is the type of company that Valeant aspired to be: a serial acquirer that elevates the profitability of its new businesses. Danaher, however, went beyond cost-cutting to create a long-term industrial-equipment franchise, earning it a reputation as one of the best-managed companies in the world.
Alas, almost none of that can be said for Valeant, which gave up some of its recent gains this week on news that bondholders will consider the company in default if it fails to file its annual report with U.S. securities regulators by month's end. The Valeant story is now sadly familiar: The plan was to avoid hit-or-miss research and development spending and assemble a wide-ranging collection of undervalued drugs through constant deal making. Accounting and management credibility issues, accompanied by public condemnation over the sharp increases in the drug prices, have left Valeant with a share price 90 per cent below its August, 2015, peak – but still holding the bag on more than $30-billion (U.S.) in deal-related debt.
Since the company's story is now in tatters, investors might consider these two stocks that do things the opposite of "the Valeant way."
Gilead has developed a dominant franchise in the treatment of HIV and then used that expertise to branch out into similar fields like the treatment of hepatitis C (or "HCV") through acquisition and its own pipeline of drugs. "Gilead's expertise in infectious diseases and single-pill formulations is a part of its research and development strategy, which we see as one of the strongest intangible assets supporting the firm's wide moat," wrote analyst Karen Andersen of Morningstar, which assesses companies' competitive "moats" that scare away competitors. Ms. Andersen assigns a fair value to Gilead shares of $128, versus Friday's close of $98.29, good for four stars in the Morningstar system.
Investors have not been as confident of Gilead's competitive strengths, as its HIV and HCV businesses have drugs that are losing patent protection in coming years or which are facing new competitors from other major drug companies. In addition, the company reports slower growth than its big biotech peers; even with Gilead shares up 20 per cent from their February low, the stock still trades at a forward price-to-earnings ratio of less than eight, versus P/Es of 12 to 18 for Biogen Inc., Celgene Corp., Amgen Inc. and AbbVie Inc, according to S&P Capital IQ.
Cowen & Co. analyst Phil Nadeau, who has an "outperform" rating and $130 target price, says the competitive threat is overblown. His projections suggest that Gilead will generate so much cash flow in the next five years, "investors are paying a modest price for any post-2020 business that remains, despite the fact that many key franchises … are patent protected until 2030 [and after]," he wrote in a recent report.
Tony Butler, an analyst with Guggenheim Securities, says Gilead's management has demonstrated a nose for identifying acquisition targets where they can add value, and executing on that after the deal is done. "Those are two really, really big home runs."
Mr. Butler, who is "neutral" on the shares because of Gilead's lower-than-peers growth profile, still applauds the company for its decisions on how to use its cash. "They're conservative. They're not out buying a collection of stuff. People want them to do that, and they're just not doing that. … They're trying to be thoughtful about how to use the money. It doesn't help the multiple of the stock, though."
To include Danaher is to kick Valeant when it's down. A source close to the senior leadership of Valeant told The Globe and Mail late last year that Valeant's outgoing CEO Michael Pearson and other Valeant board members admired Danaher and Mr. Pearson said in an interview with The Globe that "they're known as really good operators, and really good acquirers. And we'd hope one day we'd be viewed as that as well."
That may even understate Danaher's reputation. Morningstar analyst Barbara Noverini says the company has "reached legendary status" for its success in using exceptional operating discipline to grow earnings via acquisition and "generat[ing] eye-popping shareholder returns over the past 30 years."
The company's core expertise is equipment and instrument manufacturing; today, its businesses include life sciences, water quality, dental equipment and other testing and measurement devices. Its appetite for deals is unabated: According to S&P Capital IQ and Danaher's disclosures, the company has acquired 71 businesses in the past five years, including the $13.6-billion purchase of Pall Corp. in 2015.
"They are very big on innovation and very big on investing in their top line. … They will cut costs to help pay for a deal, but ultimately, what they do better than most is figure out how to get revenue synergies and drive growth," says analyst Ross Muken of Evercore ISI, who has a "buy" rating and $104 target price, versus Friday's $94.12 close. "These guys aren't hatchet men who come in and cut all of [the operating expenses] and put up great cash flow. These guys create long-term, sustainable businesses."
To buy into the Danaher story, investors have to pay up a little, however. The company's P/E is just under 20, with investors eagerly anticipating a 2016 spinoff of the company's more mature industrial businesses into a new concern called "Fortive." The spinoff, combined with the sizable integration of Pall, injects some uncertainty into what had been a smooth-running machine, some say.
"DHR's performance versus peers over time has not gone unnoticed, resulting in a persistent valuation premium that, although justifiable, does pose risk for investors," Citigroup Global Markets Inc. analyst Andrew Kaplowitz wrote in a recent note.
There are risks in both Danaher and Gilead, to be sure. They pale, however, in comparison with the risks in Valeant that were realized in such dramatic and portfolio-crushing fashion.
With files from Sean Silcoff
David Milstead