Perrigo in Neutral Lane

We have maintained our Neutral rating on Perrigo Company ( PRGO - Analyst Report ) with a target price of $112.00. Our long-term recommendation is in line with the Zacks #3 Rank carried by the stock in the short-run.

Last month, Perrigo reported its third quarter fiscal 2012 (ended March 31, 2012) earnings results. The third quarter earnings (including the tax benefit of $0.20 but excluding other adjusted items) of $1.41 handsomely beat the Zacks Consensus Estimate of $1.21 per share. Third quarter earnings increased 31.8% from the year-ago period. Earnings were boosted by higher revenues.

Net sales in the third quarter climbed 12.5% to $778 million aided by the inclusion of $70 million of net sales from Paddock Laboratories (acquired in 2011) and CanAm Care (whose assets were acquired by Perrigo in January 2012). Moreover, newly launched products boosted sales by $64 million in the third quarter of fiscal 2012. However, revenues fell short of the Zacks Consensus Estimate of $825 million. Weakness in the Consumer HealthCare and Nutritional segments contributed to the lower-than-expected revenues in the third quarter.

The Rx Pharmaceuticals (generics) segment continued to perform well and recorded an 84% increase in sales compared to the year ago quarter. We are pleased by the growing generics business at Perrigo. We note that the generic unit of Perrigo has seen quite a few approvals over the past few weeks including its generic version of hyperphosphatemia drug, Phoslo Gelcaps, and the generic version of KV Pharmaceutical Company’s vaginal cream Gynazole 1 for the local treatment of vulvovaginal candidiasis. The segment is expected to continue performing well thereby driving growth at Perrigo.

Perrigo is constantly launching new products to sustain growth. On the third quarter fiscal 2012 conference call, Perrigo announced that it has launched new products worth $160 million revenues so far in fiscal 2012. Important product launches in fiscal 2012 include the store brand version of Merck’s ( MRK - Analyst Report ) Claritin-D tablets for the treatment of nasal allergy symptoms (February 2012), the store brand version of Rogaine Foam (March 2012) and the store brand version of Novartis’ ( NVS - Snapshot Report ) heart burn drug Prevacid (May 2012).

However, we remain concerned by the below par performance of the Consumer HealthCare segment over the past few quarters. If the segment fails to meet management’s expectations or continues to generate poor revenues, the top-line will suffer significantly, as this segment accounts for the majority of Perrigo’s revenue. During the third quarter of fiscal 2012, segmental results were hurt by a mild cold and flu season. Perrigo trimmed its view regarding revenue growth for fiscal 2012 to 15%-18% (old guidance: 17%–20%) due to the same reason.

Moreover, Perrigo’s strong results in the last few quarters have benefited from external events rather than its core business. For example, the company has benefited from product recalls by competitors like Johnson & Johnson ( JNJ - Analyst Report ) in the past few quarters. Recalls at rival companies are not occurrences that happen every year and may not benefit Perrigo in the coming quarters.

In view of these challenges, we see limited upside potential of the stock from current levels.