Dr Reddy’s Laboratories: BUY. Potent pill

There has been a pause in the three-year long rally in pharma stocks. The BSE Healthcare Index lost about 9 per cent in the past month, higher than the 6 per cent fall in the Nifty Index.

But the correction offers good opportunity to buy pharma stocks with healthy growth prospects. The stock of Dr Reddy’s Laboratories has fallen by about 8 per cent over the last month.

But a sustainable growth outlook over the medium term should hold the company in good stead. With a large pipeline of products awaiting approval in the US, the company is well placed to ride the generics opportunity in this geography.

Shift in focus towards better-margin, less-competitive and difficult-to-make products such as oncology injectables, inhalers and transdermal patches should help Dr Reddy’s improve its profitability over the next two to three years.

Given that the company derives almost half its revenues from the US market, further depreciation in the rupee against the US dollar can aid margins.

The stock currently trades at about 20 times its 2015-16 expected earnings, implying a 10 per cent discount to peers such as Lupin. Investors with a two-to-three-year investment horizon can make use of the recent fall to buy the stock.

Even as peers such as Lupin struggled to grow revenues in the US market in the recent March quarter, Dr Reddy’s managed to sustain healthy double-digit growth in this geography. The company has a large pipeline of about 68 products that are awaiting approval from the US drug regulator, Food and Drug Administration.

About two-thirds of them are low-competition, better-margin, niche products such as oncology injectables and transdermal patches. Besides its own filings, acquisition of brands such as Novartis’ nicotine transdermal patch — Habitrol — should also add to the company’s sales in the US market.

Following inspectional observations raised by the US FDA at its API facility in Srikakulam (Andhra Pradesh), the company has already initiated transfer of filings for key products such as Nexium to other facilities. The remedial measures at the API facility are ongoing. Approval (when it happens) for products such as Nexium, can provide a fillip to the company’s US business.

Dr Reddy’s, through its subsidiary Promius Pharma, has filed an application with the US FDA for three innovative drugs in the dermatology and neurology space. This includes one drug-device combination which will target migraine, and two others which can be used to treat skin disorders — psoriasis and rosacea. If approved, these can provide a leg-up to Dr Reddy’s prospects in the long run.

The company has managed to sustain healthy double-digit growth in the domestic market. This was helped by new product launches, improvement in the field force productivity and healthy ramp-up in its biosimilar (biologic products) portfolio.

Its recent acquisition of Belgian drug maker UCB’s domestic brands for ₹800 crore, should help Dr Reddy’s expand its product offerings and sustain growth momentum in the home market. The acquired business had sales of about ₹150 crore in 2014.

The company’s trouble in other key markets — Russia and CIS — due to sharp depreciation in the ruble, appear to be receding. After bottoming out in January 2015, the Russian currency has strengthened against the US dollar over the last three months. Given the healthy constant currency growth in this market, the bounce back in the ruble should spell relief for Dr Reddy’s.

The company managed to grow revenues by 11 per cent in the March quarter, thanks to its healthy performance in key markets — the US, India and Europe. The company’s operating profit margin dipped by about 2 percentage points, on account of weak ruble and higher research and development expenses. However, its net profit grew 14 per cent to ₹519 crore, due to lower tax outgo.

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