Valeant Pharmaceuticals, Concordia Healthcare zoom ahead of U.S. peers

Canada’s health-care stocks are sizzling, as Concordia Healthcare Corp. and Valeant Pharmaceuticals International Inc.’s buy-and-streamline strategy has pushed the industry’s earnings and margins ahead of U.S. peers.

The drugmakers are the two top-performing stocks in the Canadian equity benchmark this year, boosting total returns for the members of the Standard & Poor’s/TSX Composite Health Care Index to almost six times that of its U.S. counterpart, according to data compiled by Bloomberg.

Valeant (VRX.TO 0.00%) and Concordia (CXR.TO 0.00%), which account for 84 percent of the Canadian health-care index, are leading gains by largely skipping the costly research and development process for drugs and buying drugmakers that have retail-ready products. They then expand earnings by cutting costs.

“They say they are going to cut the fat and share the gains with their investors,” said Umer Raffat, an analyst at Evercore ISI in New York. “They spend significantly less on research and development and run much leaner.”

The two companies have been successful in finding those cost savings. The average operating margin for Canadian health- care stocks with revenue of at least C$20 million has improved to 22 percent in the latest quarter, from 17 percent a year ago. By contrast, comparable U.S. health-care firms have improved their margin to almost 22 percent from 20 percent in the same period.

As a result, the market capitalization-weighted average total return of those Canadian health-care stocks is 62 percent this year as of May 20, compared with 11 percent for the S&P 500 Health Care Index, the data show. In the past year, sales have climbed an average 19 percent for the Canadian stocks, compared with 11 percent for the U.S.

BLOATED COSTS

Valeant Chief Executive Officer Michael Pearson, in a 2014 interview with Bloomberg, said pharmaceutical companies have bloated cost structures because they’re so profitable.

“We tend to look for companies with problems that we can fix,” he said. “We like companies that are fat, lots of costs that we can take out.”

By combining this strategy with low interest rates and a favorable tax structure in Canada, Valeant and Concordia are now beating the competition to the punch on acquisitions in an industry that saw almost $100 billion worth of deals in the first quarter.

“As long as accretion is happening, the market is rewarding it,” said Raffat at Evercore. “It’s based on next year’s earnings numbers, regardless of what is happening 10 years down the road.”

EGYPT PURCHASE?

Valeant is in talks to acquire Amoun Pharmaceutical Co., one of the largest drugmakers in Egypt, in order to expand in both veterinary and human medicines, according to people with knowledge of the matter.

The potential sale, which may value Amoun at $700 million to $800 million, would be one of the largest acquisitions of a pharmaceutical company in the Middle East, signaling a growing desire among international companies to expand in the region’s fast-growing economies.

The value of these tax benefits is reflected in a higher valuation for Concordia and Valeant shares, which the companies can use to their advantage when making takeovers using stock, said Bruce Campbell, a fund manager at StoneCastle Investment Management Inc. in Kelowna, British Columbia. His firm manages about C$110 million ($90.2 million), including shares of Concordia.

“Any time Valeant runs into a competitive situation, it’s one of the things they can use to outbid,” Campbell said. “It provides an edge when they use their stock. They can offer a higher price than someone who doesn’t have that same premium in their stock while still being accretive.”

TAX RATES

Canada’s favorable tax laws have made the country a popular destination for so-called tax inversion strategies, in which U.S. companies will acquire firms located in foreign countries with lower taxes and relocate there.

Valeant, once based in Aliso Viejo, California, merged with Mississauga, Ontario-based Biovail Corp. in 2010 and is now based in Laval, Quebec. In December, Burger King Worldwide Inc. closed its C$14.5 billion deal to acquire coffee chain Tim Hortons Inc. and move the combined company to Canada, drawing the ire of U.S. President Barack Obama.

Canada has a combined corporate tax rate of 26.3 percent, compared with a 39 percent rate in the U.S., according to data from the Organization for Economic Co-Operation and Development.

While the Canadian companies are on a roll, the streak may not last. Drugmakers that are able to find and develop new medicines generally reap the greatest rewards, Raffat said. Those who struggle with their drug pipelines may fall behind rivals who buy established products.

“It becomes company specific at some point,” Raffat said. “The difference is the success rate of the R&D. If the success rate is high, then the R&D approach wins.”