Bausch Health: an ex-sinner to buy now

Michael Pearson © Andrew Harrer/Bloomberg via Getty Images
J. Michael Pearson: BHC’s era of excess is over

Pharmaceutical firm Bausch Health, formerly known as Valeant, is putting a dodgy past behind it.

Until four years ago, Valeant Pharmaceuticals – now Bausch Health Companies (NYSE: BHC) – was regarded as one of the world’s most dynamic drug companies. In 2008, J. Michael Pearson became CEO. He argued that returns from research and development (R&D) were too low and uncertain, and instead went on a buying spree, acquiring other drug and biotech firms that he considered to be particularly promising. He also instituted a more aggressive pricing policy, as well as restricting the firm’s operations so as to minimise its tax liability. In the short run this successfully boosted profits. The share price rose 15-fold from 2010 to 2015, and Pearson was hailed as a genius.

The fall of Valeant and rise of BHC

Then it all ended. The pricing policy, plus the company’s tax management tactics, generated huge public anger, both in Canada and the US. It also became clear that much of the leap in profits was due to debatable accounting techniques, and that it was in fact losing money. In 2016, Pearson and several board members were forced to step down. By the middle of that year the share price had collapsed by 90% from its 2015 peak. Even today, the shares are worth barely more than they were nine years ago.

Given this colourful history, why should you invest in Bausch Health now? After Pearson was forced to quit, his successor, Joseph Papa, went back to basics. Some of these changes were cosmetic moves designed to signal a new era, such as the name-change. But others were more substantive. Papa reduced debt by selling many of the firms Pearson had bought. He also decided to go back to focusing on growth through traditional research and development, rather than by buying other firms. As a result, instead of a sprawling business empire, the rebranded BHC is now much more tightly focused, getting half of its revenue from eye care.

Yet despite all of these positive changes, it seems that many investors still associate Bausch Health with the excesses of the Pearson era. While the share price has more than doubled since November 2017, Bausch Health still trades at less than six times its projected 2020 earnings. This makes it look good value – it has a strong development pipeline, and its focus on eye care should mean it can benefit from long-term trends, including the ageing global population, the growth in wealth across developing countries, and the increased time we all spend in front of computer screens and devices.

Thanks to this combination of strong prospects and chronic undervaluation, as well as the fact that Bausch Health’s management looks set to announce that it has started to make a consistent profit again, I suggest that you buy at its current price of $24 at £150 per $1, compared with IG Index’s minimum of £24 per $1. With a stop loss set at $18 a share, this gives you a potential downside of £900.


Trading techniques… earnings restatements

When a company issues earnings figures, the market expects them to be accurate. However, occasionally a company issues amended figures. This can be for one of two reasons. In some cases, it has sold a revenue-generating asset and wishes to produce past figures that omit the contribution of this asset, to give investors a more realistic view of future profits. In other cases the previous figures were inaccurate, due to accounting error, improper valuing of assets, or even fraud.

Investors, of course, don’t like to hear that a company’s profits are lower than they were led to believe. In 2008, research firm Audit Analytics analysed 674 restatements issued by US firms in 2006. The analysis found that they generally had a negative impact on the share price.

A 2010 study by Mohammad Robbani, Sekhar Anantharaman and Rafiqul Bhuyan of California State University, Sacramento came to a similar conclusion – the latter study found that even positive restatements (where profits are revised upwards) depressed the share price. However, context matters. Audit Analytics found that restatements that were reported within periodic filings (such as quarterly earnings or annual reports) had only a short-term negative impact, with the share price quickly rebounding (implying that it’s a good idea to buy such shares after the initial fall). By contrast, corrections made outside this period were more damaging over the long run, with the price worsening over time. The study also found that merger-related restatements tended to have only a tiny short-term impact, whereas those involving problems with the quality of the accounting had a severe impact, in both the short and long term.


How my tips have fared

To put it mildly, this was not a good fortnight for my tips. Given that the FTSE has taken a battering, it’s no surprise that five out of my six long tips went down. John Laing fell from 381p to 376p; JD Sports fell from 618p to 582p; Bellway fell from 2,895p to 2,868p; Superdry declined from 426p to 389p; and Safestore fell from 637p to 607p. The only long that didn’t decline was Hays, which stayed at 147p. While my long positions are still collectively in the black, the net profit on them has shrunk from £1,076 to just £388.

However, if my long tips did badly, my short trades did even worse, with four out the six rising in price. Weis Markets rose from $35.61 to $38.68, and digital currency bitcoin rose from $10,252 to $11,500. Meanwhile, Just Eat surged to a peak of 780p from 642p, while Pinterest rose from $25.80 to a peak of $33.57. In both of these cases, the price rises triggered the recommended stop losses at 770p and $30 respectively. As a result, despite Tesla falling in price from $257 to $228, and Netflix dropping from $310 to $305, the profit on the short tips has gone from £893 to a loss of £1,083 (counting the losses on Pinterest and Just Eat).

Both Beyond Meat and Zoom Video Communications remain above the price at which I recommended you short them, so they are not in the portfolio. I’m also going to suggest closing the long position in Hays, since it is making a loss, after six months, as well as taking profits in John Laing (which we tipped last November). As a result, this leaves us with five long tips (including this week’s tip, Bausch Health Companies) and four shorts.