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Nath Balakrishnan

Mr G. V. Prasad, CEO -- Zyprexa holds the next big opportunity.

SHAREHOLDERS of Dr Reddy's Laboratories can consider cutting exposures in the stock, in the light of the not-so-impressive performance for the year ended March 2004. The stock has shed more than 10 per cent since its earnings announcement. Should there be a pick up in broad market indices, there is a possibility of the Dr Reddy's stock recouping some of its lost value. Investors should also use such upmoves to pare holdings.

While Dr Reddy's has been, and continues to be, one of the better patent-challenge plays available in the market today, the reliance on this high-risk, high-return strategy has not exactly come off for the company in the just-ended fiscal. Over the year, the focus was on Dr Reddy's launching a version of Pfizer's blockbuster anti-hypertensive Norvasc in the American market. With the court ruling in favour of Pfizer in the early part of this calendar year, expectations of a launch that were built into the stock price dissolved quickly and the stock's movements have since tended to carry a downward bias.

Our recommendation is predicated on the lack of any big-ticket launches in the near term, apart from increasing competition seen in its flagship generic products such as fluoxetine and tizanidine in the American market. Among the patent challenges that are coming up include the one on Zyprexa (Innovator: Eli Lilly), against which Dr Reddy's — as also Ivax— has mounted a patent challenge.

Even as Dr Reddy's has lined up patent challenges for the American market the reversal it suffered in the litigation against Pfizer tends to temper our view. Not only do such cases tend to play out over a protracted timeframe, their outcomes are, at best, couched in unpredictability. Even if the outcome of the litigation is in favour of Dr Reddy's, an appeal by the innovator is inevitable as this would further delay time to market.

The pipeline of products, although robust, does not, however, provide stability to the earnings stream. In the event of a successful patent challenge, earnings tend to peak when the challenger has a period of co-exclusivity; earnings tend to taper off after the exclusivity period ends.

Interestingly, for the quarter ended March 2004, all the abbreviated new drug application filings of Dr Reddy's are without a patent challenge, which represents a shift in its strategy, compared to some of its filings in the past.

Though such launches do not have the same financial attractiveness as successful Para - IV challenge would, it does lend the much-needed predictability to the earnings stream.

Dr Reddy's recent acquisition of Trigenesis in the US can be viewed as a positive, as it provides an entry point into a market valued at close to $6 billion. However, product filings through Trigenesis, approval by the US Food and Drug Administration and subsequent launch, may still be a couple of years away and is, hence, unlikely to have an effect on earnings in the near term.

At the current price level of about Rs 800, upside possibilities that would emerge in the event of success in a Para - IV challenge do not appear to have been factored in. However, with Dr Reddy's being one of the premier pharma plays available in the country today, a rebound from this level could also be on the cards.

Investors could use this opportunity to prune their holdings in the stock; those looking to remain invested in frontline pharma stocks could consider switching to a combination of Ranbaxy and Glaxo, which could outperform Dr Reddy's in the near-to-medium term.

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