An Interesting ETF Option for the Generic Drug Boom (RTH, XLV)

The epitome of defensive plays, low-beta health care stocks and ETFs such as the Health Care Select Sector SPDR XLV have been less bad than the broader market over the past five to six weeks, but there's a well-known issue to consider with blue-chip pharmaceuticals names and ETFs such as XLV: The patent cliff. According to S&P Capital IQ, nearly $100 billion in patent-protected drugs lose that protection between 2011 and 2015. While it remains to be seen if the U.S. and European giants that dot the lineups of ETFs such as XLV and the Market Vectors Pharmaceuticals ETF PPH have strong enough pipelines to cope with their expiring patents, there are ways for investors to take advantage of the shift to generic drugs. S&P Capital IQ thinks that opportunity lies with drug store operators such as CVS Caremark CVS and Walgreen WAG, which the research firm has five- and three-star ratings on, respectively. "We think earnings of drug retailers will increasingly benefit as the tidal wave of new generic drugs begins to come onshore in 2012," S&P Capital IQ said in a research note. "While generics are significantly lower in price than the branded drugs they replace, they contribute more to profits. We believe these increasing generic drug benefits will begin to be felt by retailers during the second quarter of 2012 following the loss of patent protection (November 2011) and generic exclusivity (May 2012) for Lipitor. Additionally, we estimate nearly $30 billion in branded drugs will lose patent protection in all of 2012." The ETF opportunity for the generic drug trend exists in the form of the Market Vectors Retail ETF RTH, which S&P Capital IQ has an Overweight rating on. "RTH currently carries an overall ETF Ranking of Overweight. Its recent holdings have largely favorable S&P STARS rankings from S&P Capital IQ equity analysts, while it also has holdings with largely high marks for S&P Quality Rankings. Additionally, the drug retail sub-industry comprises 11% of RTH's total holdings as of April 30, 2012, with CVS accounting for 6.3% and WAG for 4.6%. In the Cost Factors category, RTH receives a positive input for bid/ask spread," according to the note. RTH, which charges 0.35% per year, has held up well amid the broader market calamity of the past month, losing just 3% and the fund has other ways of gaining exposure to the potential rise in generic drug sales. Wal-Mart WMT, the Dow's top performer as of late, is RTH's top holding with a weight of 13.3%. Target TGT, with a weight of almost 5.1%, is another RTH top-10 holding. Both companies have major pharmacy operations where they sell generic drugs.