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The generic drug market has continued to gain prominence within the pharmaceuticals sector in recent years. Generic growth has benefited from a number of favorable dynamics, including increased availability as a result of patent expirations, strong consumer demand for cheaper healthcare alternatives, and a greater willingness on the part of pharmacies and retailers to promote higher-margined generics. Investors have benefited as a broad array of pharmaceutical industry stocks with exposure to generics have performed well in recent years. 

The generic Rx business has traditionally been viewed as the more attractive sector. Yet, the generic over-the-counter (OTC) segment has rapidly expanded over the past few years, fueled by a steady stream of Rx-to-OTC switches, and increased assortment of store brand variations. OTC generic demand clearly accelerated during the recent economic downturn, as more consumers turned to cheaper alternatives.

This trend has been met with increased emphasis on generics, particularly private label/store brands, by retailers. OTC generics have much higher margins for retailers than the branded counterparts, in some cases more than double. This has resulted in many large pharmacies and retailers offering their own store branded versions of most major OTC products. These store brand copies are manufactured by the generic drug maker, with the store or private label brand on the packaging.

Although there are many competitors that specialize in generic OTC products, the segment is dominated by a single company. Perrigo (PRGO) is the clear heavyweight in the generic OTC market, with a 70% market share. The company is the go-to-provider for a wide assortment of products for the private label brands of leading retailers like Wal-Mart (WMT - Free Wal-Mart Stock Report), Target (TGT), Kroger (KR), and Costco, as well as pharmacies, such as CVS (CVS) and Walgreens (WAG). Perrigo has grown to become one of the five largest pharmaceuticals companies by volume, with annual production of over 44 billion tablets, representing over 13,000 SKUs. Perrigo’s dominant and entrenched position in the U.S. market is enhanced by its vast manufacturing capacity, nationwide distribution network, and proven expertise in offering a full turnkey operation including packaging and marketing. Moreover, the company’s relationships with leading retailers, including exclusive supplier agreements, further solidifies its position and creates significant barriers to entry for new competitors.

The generic OTC business is Perrigo’s core unit, but the company has diverse operations across a number of complementary divisions. The Consumer Healthcare (OTC generic business) segment accounts for approximately 60% of revenues, while Nutritionals contributes nearly 20%, with Generic Rx and Active Pharmaceutical Ingredients (API) making up the remainder. Perrigo has used aggressive dealmaking to diversify its operations, expand globally, and gain entry to new business segments. The company has purchased a dozen companies over the last four years for a combined total of $1.8 billion. The acquisitions have also played a large role in boosting growth. The most recent significant deals include the PBM infant formula business, which represents the bulk of the Nutritional segment, and Paddock Laboratories, which has strengthened the Rx generic business.  The two additions provide $500 million in annual sales, with attractive growth prospects. The private-label infant formula business is a great fit, given its complementary nature and PBM’s dominant position in the market with no real generic competition.

The ability to quickly bring new products to market has played a large role in Perrigo’s success. The company actively monitors potential opportunities including filing in advance for Rx-to-OTC switches. New product launches have fueled recent results, as PRGO has been able to capture significant market share despite competition.  Significant launches over the past couple of years include OTC Cetirizine (Zyrtec), which has captured an impressive 80% of store brand market share, and Omeprazole (Prilosec), which now accounts for over $200 million in annual sales (about 10% of overall revenues). Recent product launches, include generic versions of OTC Allegra and Nasacort. Meanwhile, the company has a strong product pipeline, headlined by Mucinex, Clarinex, Delsym, and Prevacid. New launches should continue to make substantial contributions to results in the coming years. Notably, there is a sizable opportunity with upcoming Rx-to-OTC switches, with products worth an estimated $10 billion in annual branded sales expected to make the transition over the next five years.

There are other companies that compete in the generic OTC drug space that investors might find attractive, particularly considering PRGO’s premium valuation. These include Dr. Reddy’s (RDY) and Watson Pharmaceuticals (WPI). Notably, Dr. Reddy’s competes with PRGO on a number of recently released products, and has become an emerging force in the generic industry. The company, which is based in India, has a strong position in its domestic market, along with an expanding presence in Russia and the United States.

The outlook for the generic market remains favorable, with strong demand from consumers and retailers alike. The generic OTC segment should continue to perform well, and has solid new product visibility with a strong pipeline of Rx-to-OTC switches over the next few years. Perrigo is poised for strong growth with its dominant position in the generic OTC market, and should continue to expand both organically and through acquisitions in the coming years. The stock should appeal to investors who are looking for exposure to the broad generic market, and the OTC/store brand business in particular.

 

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.