The ongoing market correction presents a good opportunity to add the blue-chip, Dr Reddy's Laboratories (DRL), stock to your portfolio. Strong generic opportunities in the US, supported by its pipeline of product releases, favourable positioning in Russia and expanding bio-similars portfolio promise a healthy growth potential for the stock in the long run.

While headwinds such as weakening domestic business, US FDA's import ban on its Mexican facility and sustained pricing pressures in the German market may keep the stock price pressured in the short-term, its current valuation presents a good buying opportunity for long-term investors. At the current market price of Rs 1,448, the stock trades at about 18 times its likely FY12 per share earnings.; much lower than that of CNX Pharma (26 times).

US, Russia, to drive growth

Steady growth in its baseline revenue and upsides from periodically successful Para IV ‘first-to-file' launches in the US (either with 180-days exclusivity or as an authorised generic supplier to the innovator) buoy up the growth prospects for the company. DRL filed 21 abbreviated new drug applications (ANDAs) in 2010-11, taking the cumulative total to 179 ANDAs (including partnered ANDAs). The company has 76 pending approvals, of which 36 are Para IV filings and 11 are in the ‘first to file' category. The company also filed 56 drug master files (DMFs) in 2010-11, taking its overall count to 486.

For the quarter ended June 2011, DRL's global generics business grew by over 21 per cent, driven primarily by strong growth in North America (up by 48 per cent), which was led by launches of last year and market share increase across key products — lansoprazole, tacrolimus and omeprazole OTC, to name a few. With several new launches — Allegra D24 and Olanzapine — expected this year, the US is likely to remain the revenue driver.

That it recently received a final nod from the US FDA to launch the fondaparinux sodium injection — a bioequivalent generic version of GSK's Arixtra — would also support growth in the US. The approval opens up significant earnings potential for the company, considering that the Arixtra brand had US sales of approximately $340 million for the 12-months ending May 2011.

The company plans to launch the generic in phases, given the complex manufacturing of the product and first concentrate on the wholesale and retail chains (40 per cent of the market). The drug could add up to a profit per share of about Rs 3 for DRL in FY12. While there is a possibility of the entry of an authorised generic here, there is no clarity on that yet. If an AG does enter the market, gains for DRL could be limited.

DRL's acquisition of GSK's penicillin facility in the US opens up newer avenues for growth as it has allowed the company an entry into the US penicillin-based anti-bacterial market segment (through brands such as Augmentin and Amoxil).

The management expects the new GSK facility to achieve peak sales from Q3FY12 and to average $5 million sales per month on an annualised basis. On the whole, the management expects to post higher growth and profits in the second half of the year.

Improving prospects in the Russian market also support DRL's growth underpinnings. Helped by a strong growth in the OTC portfolio and key prescription products, the company's rank in the market now stands at 13. Its OTC business has increased from 25 per cent of the Russian revenues to 30 per cent over the year. In the just-ended quarter, DRL managed a strong show in Russia with a 20 per cent growth.

India drags

The company's performance back home, however, leaves a lot to be desired. In the June-2011 quarter, DRL registered a modest 6 per cent domestic sales growth, much lower than the industry average of about 14 per cent. Competitive pressure in acute therapeutic segments and low productivity and high attrition among its field agents (500 agents added last year; current count 3,800) contributed partly to this.

While the management expects the growth to revert to normal by the second half of the fiscal, it could take longer, given the high competition in the domestic market. Growth trends in coming quarters will therefore need to be monitored.

Other concerns

Among the other concerns is its recent warning letter from the US FDA for its Mexican facility. The facility raked in revenues of about $60 million a year. With Naproxen, which is a $30 million product, exempt from the ban, the revenue impact of the ban will be limited to $30 million only. Though the revenue impact of the same is not significant, a timely redressal of the issue would be a sentiment booster.

The company's Germany-based subsidiary, Betapharm, continues to face pricing challenges. However, with US business growing significantly, the lower contributions from Betapharm wouldn't deeply impact the company's overall performance.

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