Dr Reddy’s Laboratories: Buy

Even as most pharma stocks cheered the appreciation of the rupee against the dollar over the past month, the stock of Dr Reddy’s Laboratories has shed over 15 per cent in this period. The free-fall in oil, consequent strain on the Russian economy and depreciation of the rouble against the rupee weighed on the stock.

However, the earnings impact on account of the rouble depreciation and Russian crisis is unlikely to be material, given that about two-thirds of the company’s exposure to the rouble is hedged. At the current price of ₹3,217, the stock trades about 19 times its 2015-16 earnings, making it the cheapest stock in the large-cap pharma space.

Dr Reddy’s has been building a pipeline of differentiated products, the benefit of which is expected to accrue beginning 2016. Given the good growth visibility in the medium term, investors with a three-year investment perspective can use the weakness in the stock price to add it to their portfolio.

Research spend up Russia and CIS is the third largest market for Dr Reddy’s, next only to the US and India. This geography accounts for about 14 per cent of the company’s revenues and operating profit.

However, the company enjoys a natural hedge, as rouble-denominated outflows (expenses) constitute about 50 per cent of its Russia and CIS revenues. And about a third of its rouble receivables are hedged.

Hence, less than a fifth of the company’s revenues from the Russian and CIS markets are expected to be impacted by the steep depreciation in the rouble. So, the stock’s over-reaction to the rouble fall clearly presents a good buying opportunity.

Dr Reddy’s has stepped up investment in research over the last two years. From about 7-8 per cent of revenues, the total spend on research and development has gone up to almost 12 per cent now. The company is also focussed on building a portfolio of differentiated products for the US market, which will have limited competition. The company has 72 generic drug filings which include 11 exclusive opportunities and two new drug applications that are pending approval. The cumulative market size of these drugs stands at $40 billion. Of these, about a third are complex, difficult to manufacture oral solid drugs and injectables.

New launches In the near term, generic product opportunities in the US such as AstraZeneca’s heart-burn drug Nexium and Teva’s multiple sclerosis drug Copaxone, once approved, may be the key growth drivers for Dr Reddy’s.

With the US drug regulator — Food and Drug Administrator –—— revoking the approval given to Ranbaxy for its generic version of Nexium, other generic filers such as Dr Reddy’s, which have already settled with the innovator AstraZeneca, can launch the drug on receiving approval from the US FDA.

Nexium, which enjoyed sales of $2.3 billion in the US, can add over $150 million annually to Dr Reddy’s revenues.

Likewise, Copaxone, which contributed over $3 billion to Teva’s revenues, can also add in excess of $200 million to Dr Reddy’s sales. Similarly, the company has also filed for a generic version of Novartis’ blood cancer drug Gleevec; this drug had sales in excess of $2 billion. These opportunities may provide a big leg up to the company’s sales over the next two years.

In addition to exclusive launches in the US, any further depreciation of the rupee against the dollar, can further boost the company’s profitability in the medium term.

For the April-September 2014 period, Dr Reddy’s revenues grew 15 per cent compared with the same period last year. Operating profit margin for the first half of the fiscal stood at 23.6 per cent, higher by 60 basis points. Net profit grew 15 per cent in the first half of 2014-15.

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