Valeant Pharmaceuticals will report its Q4 earnings on February 28th. VRX stock remains a risky bet going into the earnings.

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Valeant Pharmaceuticals Intl Inc (NYSE: VRX) stock has been rallying going into this earnings season. Valeant stock is up by more than 20% since the beginning of February. VRX stock is currently facing resistance from the 100-day simple moving average trendline. The run in the stock has been driven by the FDA approval of "Saliq", a drug marketed by Valeant to treat adults with moderate-to-severe plaque psoriasis, and the company's asset sales plans. Valeant has announced asset sales of more than $2.5 billion since the beginning of the year. These asset sales will help in paring down some portion of Valeant's $30 billion debt which is holding down the stock.

Valeant's revenue decline will continue

The Quebec-based specialty pharma company is scheduled to report its Q4 and FY 2016 earnings on Tuesday, 28th of February. Valeant's revenue has been on a consistent decline over the past year and is expected to continue the trend for some time now. Analysts' expect the company to report an EPS of $1.22, down more than 50% from last year's Q4 EPS of $2.5. On the revenue front, analysts expect Valeant's revenue to decline by 16% to $2.34 billion. These estimates have been revised downwards multiple times over the past year. Given Valeant's recent history, there is a strong chance that the company may miss even on the revised earnings estimates. In the previous four quarters, Valeant Pharmaceuticals has missed earnings estimates by 6% to 16%.

2017 guidance will be the key

The recent asset sale plans will help the company in paying down its huge debt burden. The company has also identified another $8 billion of non-core assets which it can use for paying down its debt. But these assets sales will also impact its potential revenue and EBITDA, which Valeant can ill afford at this juncture. According to bond covenants which Valeant recently re-negotiated, Valeant needs to maintain interest coverage ratio above 2. Further loss of revenue will put pressure on its coverage ratio.

Valeant needs to maintain a fine balance between asset sales and future cash flow potential. To get investors interested, the company will need to sell fast growing high margin assets (in this case, CereVe, which has demonstrated >20% growth over the past two years) which could significantly affect its future cash flows and sales. Valeant is expected to lose upwards of $500 million in sales due to the planned asset sales. Many analysts have revised down their forecast for 2017, including RBC and JP Morgan. To quote JPMorgan analyst Chris Schott:

Following Valeant’s recently announced divestitures and ahead of 2017 guidance, we wanted to refresh estimates and update our outlook for Valeant. We are again lowering our estimates to reflect 1) the company’s recently announced asset sales, 2) a more conservative view of Valeant’s diversified products division and 3) FX headwinds. Our new 2017 EPS and EBITDA estimates are $4.30 and ~$3.7bn. While Valeant’s recent divestitures are a step in the right direction (helping to meet near-term debt reduction goals), we still see a challenging setup for the story with significant leverage and modest growth potential.

Census analysts' estimate for Valeant's 2017 revenue has fallen from more than $14.5 billion in October 2015 to the current estimate of $9.01 billion. During its Q3 earnings call, Valeant had said that 2017 EBITDA will be lower than 2016 EBITDA (mostly due to asset sales), though it did not quantify the decline. A steep decline in EBITDA would put the stock under heavy pressure. Investors will be keeping an eye on the EBITDA guidance. According to RBC’s Douglas Miehm and Joel Hurren an EBITDA below $3.75 billion will be a bad news. They expect 2017 EBITDA to be in the range of $3.8-$4.1 billion.

Should you buy Valeant stock going into the earnings?

Valeant stock presents a very aggressive risk-reward proposition going into the earnings. Wall Street currently has an average price target $22.39 indicating 35% upside from current price. The stock could go even higher on a strong guidance, approval of new drugs or additional non-core asset sales at good valuations. However, a miss on earnings or weak guidance could tank the stock. Risk-seeking investors could consider getting in the stock before the earnings.