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Back to Neutral on Warner Chilcott

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We are reverting to a Neutral recommendation on Warner Chilcott plc from Outperform as we believe that the stock is fairly valued at current levels with limited upside potential from current levels. Our target price is $15.00.

Why the Downgrade?

Warner Chilcott’s revenues declined 5% in the fourth quarter of 2012. Revenues were hurt by generic competition faced by products such as Actonel (osteoporosis) and Doryx (dermatology).

On Apr 30, 2012, a US district court issued a verdict regarding Mylan, Inc. (MYL - Free Report) and Impax Laboratories’ applications to the US Food and Drug Administration (FDA) to sell their respective 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. The generic threat is expected to intensify in the coming years. The genericization of key products will make it challenging for the company to drive the top line.

We are also concerned about the weak late-stage pipeline at Warner Chilcott with erectile dysfunction candidate Udenafil being the only late-stage candidate. Given the generic competition faced by the key drugs at Warner Chilcott, the pipeline must deliver. Generic competition is likely to intensify further at Warner Chilcott going forward. Consequently, the lack of a decent late-stage pipeline is a matter of concern.

In Mar 2012, Warner Chilcott received a warning letter from the FDA regarding its Fajardo facility in Puerto Rico for its oral contraceptive Ovcon 50. Even though the company responded to the warning letter in Apr 2012, we believe that any slip on the company’s part to comply with the FDA’s quality control requirements will invite strict action from the US regulatory body. Such an action will weigh heavily on the stock.

In view of these challenges, we see limited upside potential from current levels and hence downgrade the stock to Neutral.Warner Chilcott carries a Zacks Rank #3 (Hold) in the short run.

However, Lannett Company, Inc. (LCI - Free Report) is favorably placed in the pharma sector. The stock carries a Zacks Rank #1 (Strong Buy) and is worth considering.

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