Dr Reddy’s Laboratories

Investors with a long-term horizon can consider buying the stock of Dr Reddy’s Laboratories (DRL) given its strong product pipeline, strengthening presence in key markets such as North America, Russia and India and the reduced uncertainty about the fortunes of its German business, Betapharm.

The earlier-than-expected approval for the company’s OTC generic Omeprazole by the USFDA also strengthens the case for investing in the stock. At the current market price of Rs 705, the stock trades at a somewhat high valuation of about 14 times its likely FY-10 per share earnings.

While Dr Reddy’s fairly stable line-up of Para IV and first-to-file pipeline and continued revenue contribution from the sale of Sumatriptan (the authorised generic version of GlaxoSmithKline’s Imitrex) provide for revenue upside, the recent surge in its stock price may stand in the way of any near-term gains. Investors should phase out their exposure to the stock.
Strong pipeline

Dr Reddy’s has a fairly strong pipeline of over 67 new drug applications pending approvals by the US FDA (Food and Drug Administration), which represent a substantial earnings trigger for the company. The latest USFDA approval for the company’s Omeprazole Mg drug, which is the generic version of AstraZeneca plc’s Prilosec, is a case in point. The approval will grant DRL access into a roughly $362 million market, which features just another generic player, Perrigo.

That said, the company will be tested on its marketing and brand recall prowess since the product will be OTC (over the counter) and not prescription-based.

Revenues from this product, therefore, will depend on client and order wins (with retail chains) by DRL.

However, since the formulation patent expires only in 2014, it leaves DRL with sufficient time to capitalise on this business opportunity. That the company already has ongoing relations with US retail chains such as Walgreens and Wal-Mart may also help.

The management expects to gain from at least one such high-value opportunity every year. Sumatriptan sales, which had pepped up the revenues significantly since its Nov ‘08 launch now enjoys a share of over 50 per cent in the market, which features four players.

This revenue opportunity, however, may remain only till August ‘09, by when DRL is slated to lose its exclusivity. This may lead to a decline in the company’s operating performance.

Launch of the generic Fondaparinux, which is used for the treatment of deep vein thrombosis, would be the next key earnings trigger to watch out for as the US regulator has already marked DRL’s application under priority review. Fondaparinux, which is marketed by GlaxoSmithKline under the brand name of Arixtra, had sales of about $180 million in the US in 2008.
Russian stronghold

Despite concerns of a falling ruble, DRL improved its revenues from Russia and CIS, well within the credit limit offered to its customers, by effecting price hikes.

It managed to grow its volumes by over 11 per cent in the country despite an industry de-growth of 0.2 per cent. Its stronghold is further reflected in the fact that its top ten brands in the country contributed to over 79 per cent of the revenue growth.

Overall, revenues from Russia registered a 43 per cent growth in FY-09. The management expects to maintain a healthy growth rate this year. However, excessive forex fluctuations can play spoilsport.
Betapharm in better position

Concerns over DRL’s German arm appear to be on the wane, with Betapharm securing 33 contracts with German health insurer, AOK. Its contracts make up 18 per cent of the overall volumes awarded by the insurer.

Besides, since DRL’s products have been cleared of the legal hurdles, it will soon start supplying its products. But given the German market’s transition to a tender supply market, margins are likely to be on the low side.

Moreover, since the eight products under the AOK tender are not among the top ten products of the company in the region, it may also result in de-stocking of those products.

For FY-09, the company recorded a one-time non-cash impairment loss with respect to intangible assets (Rs 316 crore) and goodwill (Rs 1,085 crore) in its German business, driven primarily by the shift in market dynamics towards tender-based supply model, characterised by decrease in market prices.

So while increased volumes and product launches may lead to Betapharm’s growth, the management expects to maintain profitability by cutting costs. It plans to cut down its sales force and shift manufacturing and select functions to India.
Domestic business

For FY-09, DRL’s sales growth in India remained muted at 5 per cent due to supply chain restructuring (to replenishment based-model) and a slow pace of product launches.

The management expects to ramp up product launches, both in-house and licensed, and increase product reach and coverage to grow from hereon.

Besides, it plans to tap corporate hospitals and rural areas. As for its Pharmaceutical Service and Active Ingredients (PSAI) business, which had suffered from fall in sales growth led by global inventory de-stocking and credit crunch, the management expects to pick up in performance by the second half of the year.

It has indicated at a reversal in trend with improved order booking. DRL’s strong IP expertise and DMF pipeline may help improve its score.

via BL