Technical Strength in 3 Drug Makers

09/07/2011 9:30 am EST

Focus: STOCKS

Kate Stalter

CMO & Senior Financial Advisor, Better Money Decisions

The technical strength in gold-related stocks is front and center these days, especially as the rest of the market is led lower on economic concerns and worries about European sovereign debt. But for investors who want to expand their watch list to include sectors other than metals, some of the generic drug makers are worth a look, writes MoneyShow.com contributor Kate Stalter.

As the market plunged Tuesday, one of the names that bucked the trend was Michigan-based generic drug maker Perrigo (PRGO).

The stock rebounded off its 40-week average last month, and has been bouncing around its ten-week line recently.

Last week, the stock rallied to an all-time high of $97.29, but pulled back as the broader market tumbled. The gain followed news last Tuesday that the FDA had given its OK to Perrigo’s generic version of Extina foam, which treats seborrheic dermatitis, a condition that causes flaky skin.

Perrigo said it’s already begun shipping its version of the product.

The company also makes store-brand versions of over-the-counter drugs. For example, its products include a store-brand acetaminophen product, which is an alternative to Johnson & Johnson’s (JNJ) Tylenol.

Perrigo is a stock that has had both fundamental and technical strength going for it. The company has amassed a solid track record of year-over-year earnings and sales growth, as penny-pinching consumers and health plans opted for generic alternatives to name-brand pharmaceuticals.

The pace may slow a bit, however, with Wall Street eyeing income of $4.61 per share this year, a gain of 15% over 2010. That’s good, but the fastest-moving growth companies often boast even higher rates.

On the chart, you can easily see how the trading pattern has become more erratic in recent weeks, as the market itself went into whipsaw mode. Both upside and downside volume were above average.

However, if the stock continues to find support at its ten-week line, that could bode well for future price gains. Buying at the ten-week is often a signal that institutional investors are jumping in to bolster existing positions, an indication that they remain confident about the company’s prospects.

Another company in a similar line of business is Watson Pharmaceuticals (WPI), a New Jersey company that makes generic oral contraceptives, smoking cessation products, and analgesics. It also makes branded pharmaceuticals, such as Rapaflo, to treat symptoms of an enlarged prostate.

Earnings growth at Watson has accelerated recently, and Wall Street expects good numbers ahead, with profit increases of 30% and 27% in each of the next two years. Many industry watchers are anticipating strong sales of Watson’s generic version of Pfizer’s (PFE) Lipitor in November.

Lipitor has been a blockbuster anti-cholesterol drug for Pfizer. Watson has a 180-day term of exclusivity on the launch; after that, other generic drug makers can release their versions.

Watson’s chart shows the stock testing resistance at its ten-week line. Upside volume in recent weeks has not been impressive, a mark in the “negative” column.

However, its consolidation in recent weeks was not too dramatic, with the stock declining 18% from its 11-high of $71.50, reached on July 26.

Watson’s current price action is outperforming the general market. Stocks that hold up while the market is plunging can be some of the names poised for more gains after a new broad uptrend begins. That was the case in early 2009, when names like Baidu (BIDU) and Green Mountain Coffee Roasters (GMCR) were sporting strong technicals while the major indices were still floundering.

Watch for heavy-volume buying in the coming days and weeks. However, as always, consider new buys carefully in down-trending markets, such as the one we’re now in.

As we see on a regular basis, global and domestic economic events have potential to send stocks suddenly in one direction or the other. Even strong stocks showing a longer term trend of institutional buying can nosedive on an entirely unrelated piece of global news, shaking out holders lacking conviction.

Generic drug maker Hi-Tech Pharmacal (HITK) has notched upside trade for the past three weeks, after getting support at its 40-week line.

The Long Island-based company is a small cap, at just $372 million. It moves just 185,000 shares per day, adding risk for individual investors.

The company makes generic drugs to treat a range of ailments, including asthma and dermatological disorders. It also makes branded over-the-counter nutritional supplements and other products.

Hi-Tech reports its fiscal first quarter on Wednesday, before the market’s open. It’s expected to deliver per-share income of 84 cents on sales of $54.07 million. Those would mark year-over-year increases on the top and bottom lines.

Despite the good results expected in the first quarter, analysts expect Hi-Tech to show an earnings decline in fiscal 2012 to $2.71 per share, from $3.36 in 2010.

That’s a potential red flag, as fast sales and earnings growth are elements that attract professional investors, who send a stock’s price higher.

However, recent price action has outpaced the S&P 500, so investors are seeing some potential in the stock and buying in. As with Perrigo, Hi-Tech saw price gains Tuesday amid the broader market sell-off.

The projected earnings decline could put a damper on future price growth. But for now, upward momentum is in the stock’s favor, and this could be another to keep an eye on, as it approaches its former price high.

Of course, the earnings report—in particular, any guidance or information about margins or future sales—could put a fast halt to the upside momentum, so be aware of that.

At the time of publication, Kate Stalter did not own positions in any of the stocks mentioned in this column.

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