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Warner Chilcott Evenly Poised

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We are maintaining our Neutral recommendation on Warner Chilcott plc with a target price of $12.00. The stock carries a Zacks #2 Rank (Buy rating) in the short run.

Warner Chilcott reported higher-than-expected revenues and earnings in the third quarter of 2012. Results for the quarter were announced earlier in the month. Lower selling, general & administrative costs aided earnings in the third quarter of 2012.

Revenues in the third quarter of 2012 declined 7% to $606 million. The decline was primarily attributable to lower sales of its osteoporosis drug, Actonel -- acquired from Procter & Gamble Co. (PG - Free Report) in 2009 -- due to generic competition. Moreover, reduced sales of dermatological product Doryx also hurt revenues in the reported quarter. Revenues, however, beat the Zacks Consensus Estimate of $601 million.

With a significant part of its top line likely to be exposed to generic competition in the next few years, Warner Chilcott is looking towards cost-cutting initiatives to boost the bottom line. Following the genericization of Actonel in Western Europe in late 2010, Warner Chilcott announced in April 2011 its decision to reorganize its operation in Western European nations, such as Belgium, the Netherlands, France, Germany, Italy, Spain, Switzerland and the UK.

Cost savings due to the restructuring led the company to lower its 2012 guidance for selling, general and administrative (SG&A) costs. SG&A expenses for 2012 are now expected in the range of $725-$775 million (previous guidance: $775-$825 million). Research & development (R&D) expenses are now projected in the range of $90-$110 million (previous guidance: $100-$120 million). Warner Chilcott’s 2012 adjusted earnings guidance is driven by reduced operating cost projection. The company now expects adjusted earnings in the range of $3.75-$3.85 (previous guidance: $3.55-$3.65). We expect Warner Chilcott to achieve the guidance easily.

We remind investors that Warner Chilcott suffered a huge blow regarding the 150 mg dosage of Doryx earlier in the year. On April 30, 2012, a US district court issued a verdict regarding Mylan (MYL - Free Report) and Impax Laboratories’ applications to the US Food and Drug Administration (FDA) to sell their generic versions of the drug. The court ruled that the generic versions of neither of the companies infringed the patent of Doryx. Following the verdict, Mylan has entered into the US market with its generic version of Doryx 150 mg.

Furthermore, drugs such as Loestrin and Enablex are expected to go off patent in the US in 2014 and 2015, respectively. The genericization of key products will make it challenging for the company to drive the top line.

Moreover, the weak late-stage pipeline at Warner Chilcott also bothers us. In view of these challenges, we see limited upside potential from current levels.

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