Stock Fundamentals

Dr Reddy’s Laboratories: Still healthy

Nalinakanthi V | Updated on January 15, 2018 Published on March 19, 2017

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The company should revive from the regulatory setback

It has been a rough ride for pharma stocks over the last couple of years, thanks to the increased regulatory activism, particularly in the US.

While the regulatory issues facing Indian companies have been a sentiment dampener, these need to be viewed in the light of the company’s ability to ensure compliance and the growth opportunity over the medium to long term.

Regulatory overhang

The knee jerk reaction to regulatory problems involving large pharma companies with a good track record presents a good long-term buying opportunity. Among these is the stock of Dr Reddy’s Laboratories. It has shed over 13 per cent in the last two months, following reports of fresh observations by the US drug regulator Food and Drug Administration (FDA) at three of its plants — Srikakulam and Duvvada facility in Andhra Pradesh and Miryalaguda facility in Telangana.

The three facilities which came under the FDA scanner in November 2015 were re-inspected early this year and fresh observations were raised during the re-inspection.

This came as a blow to investors who were hoping for resolution of issues at these plants and triggered the steep correction in the stock price.

While regulatory overhang remains a concern, investors with an appetite for high risk and holding period of at least three years can consider buying the stock for two reasons.

First, thanks to the sharp fall in the stock price, it now trades at about 16 times its estimated 2018-19 earnings.

This implies a deep discount of 20-40 per cent to other large cap peers, such as Lupin, Sun Pharma, Cipla and Cadila Healthcare. Given the healthy product pipeline and good medium-term growth prospects, the stock seems attractively priced at current levels.

Second, after a modest growth in India in 2016-17, the company is anticipating a pick up in the growth pace in the home market in 2017-18. The management had earlier guided for double-digit growth in the Indian formulations business.

Third, the growth for the company’s biosimilar portfolio in the emerging markets is gaining momentum. This should help partially compensate for the concerns in the US market.

Also, Dr Reddy’s performance in the Russian market is expected to be healthy in 2017-18. Besides, its strong pipeline of 92 products (2 of them are new drug applications) that are awaiting US FDA approval makes the stock an interesting proposition. But risks exist.

Resolution of regulatory issues at these facilities is critical for the company to be back on growth track, given that almost a fourth of the pending filings are from these facilities.

Reports suggest that the observations at the Miryalaguda facility do not seem serious and are more procedural in nature.

Growth to pick up

However, the nature of the 13 observations made at the Duvvada facility is unclear and all the three facilities need to receive regulatory clearance to be able to resume sales to the US. Also increased competition in the US for select products, including generic version of anti-cancer drug Dacogen, were dampeners.

For the nine-month period ended December 2016, the company’s revenue declined 10 per cent y-o-y due to a 15 per cent fall in US revenue as a result of higher competition in select drugs and injectables portfolio.

Though the operating profit margin remained weak in the initial two quarters, it staged a recovery in the December quarter to 23.7 per cent, vis-à-vis 15.2 per cent for the first half of the fiscal.

Published on March 19, 2017

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