Update on Drug Stocks: Sell Dr. Reddy's, Buy Perrigo

Includes: PRGO, RDY, TEVA
by: Glenn Rogers

We originally recommended Dr. Reddy's Laboratories Ltd. (NYSE: RDY) on June 22, 2009 (IWB #2923) when it was trading at $15.30. The stock closed Friday at $31.20 (all figures in U.S. dollars). When the stock reached $24.02 we suggested taking half profits and now that the stock has continued to surge, closing on Friday at $31.20, we are suggesting selling based on valuation. We have a profit of 104% in 13 months based on the original recommended price.

I still like the generic healthcare space, and Dr. Reddy's has had a great run, but I think Teva Pharmaceutical Industries (NDQ: TEVA) is a better buy right now and it too will benefit from the ongoing shift to generic drugs. Brand-name drugs including Copaxone for multiple sclerosis and Azilect for Parkinson's disease are expected to show double-digit percentage sales growth going forward which will also drive share price. As the huge health care bill in the U.S. gradually gets implemented, the business climate for generic drug makers should continue to be positive but at a trailing p/e ratio of 240.41 I just think RDY is getting pricey.

On the other hand, Teva, which closed on Friday at $54.33, is trading at a p/e of 15.2. Teva is not on our Recommended List at the moment so I am adding it now as a replacement for RDY.

We originally recommended another healthcare stock, Perrigo Company (NDQ: PRGO), on June 22, 2009 (IWB #2923) at $26.81. We suggested taking half profits at $50.68. The stock closed Friday at $57.29 (all figures in U.S. dollars). It is now trading at a p/e of 21.9. Perrigo is obviously not the screaming bargain it was at $26.81, but given the company's continued growth prospects, it still looks like a buy now. It just acquired the rights to private label the allergy drug Allegra and hair loss treatment Rogaine. I wasn't crazy about the fact that the CFO recently sold a sizable block of shares, but perhaps he had scheduled those for tax reasons.

Barron's recently updated this stock and said the following:

The Perrigo glow may not wear off anytime soon. Even if the economy improves, many consumers are likely to stick with Perrigo products that have proven effective. Some brand-name treatments cost more than $100 apiece. The dollar savings from such products is probably too large to forgo.

Indeed, private-label pharmaceuticals already account for about 25% of the OTC market, according to Louise Chen of Collins Stewart. It is a more vibrant sector than private-label food items, which have a share of less than 20%.

So I'm going to suggest selling RDY and moving your profits into TEVA and PRGO.

Action now: Sell RDY. Buy Teva with a target of $64 and buy Perrigo with a target of $70.

Disclosure: Author is long PRGO

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