Dr Reddy's Labs Ltd

Shareholders can consider booking profits on their holdings in Dr Reddy's Laboratories (DRL). The stock has since our last ‘buy' recommendation gained over 60 per cent. While a strong set of numbers in the just-ended December quarter, potential exclusivity revenues from products such as Prilosec OTC, Allegra D24 and Arixtra and the likely expansion in market reach through its alliance with GSK promise growth potential, the stock appears to have priced in most of these potential positives.

At the current market price of Rs 1,132, the stock trades at about 23 times and 19 times its likely FY-10 and FY-11 per share earnings, leaving little room for significant near-term upsides. Besides, the recent non-cash write-down of intangible for its German arm and lowering of the current year revenue guidance by the company will also check any near-term gains for the stock.

Strong business dynamics

The strengthening base business of Dr Reddy's (minus exclusives), with a focus on US, Europe, Russia, CIS and India provides for a sustainable source of revenues in the coming years. The company put up a strong show in most of these markets even in the latest quarter. Minus the exclusivity sales of Imitrex that helped prop up revenues last year, the company recorded a decent 17 per cent growth in overall revenues during the quarter. Growth percentage would have been even higher had it not been for the lagging contributions from its US business. DRL's US revenues suffered on account of voluntary product recalls, FDA inspection and late launches. But with all these issues resolved now, the US revenues can be expected to be back on growth track in a couple of quarters.

The management expects its US operations to drive the global generics growth in the coming years. Given its fairly strong ANDA pipeline and a stream of exclusive product launches lined up for the next couple of years, the US business does seem to hold the key to drive DRL's growth aspirations. The management expects to achieve $3 billion of revenues by fiscal 2013.

But even as the US market may be the key to future growth, DRL's improving prospects in the Russian and domestic market cannot be ignored. In the December quarter alone, it managed to grow its domestic revenues by about 34 per cent. While a low base would have also helped, what's notable is that the company has taken to launching products to support growth (18 last quarter).

Having traditionally lagged most of its peers in this respect, the company's strategy to launch products to drive domestic growth may help it keep up the momentum. So far this fiscal, DRL has launched 56 products across various therapeutic areas.

Supply-chain improvement, a strong field force and the company's rural market initiatives may further help expand its domestic footprint. Another market in which the company has been able to scale growth rates higher than the industry average is that of Russia. Helped by a combination of price hikes and volume expansion, the company managed to grow its Russia income by about 45 per cent in the quarter. Though the company may not be able to maintain similar growth rates in future — price hikes were linked to devaluation of the ruble — Russia will continue to be a key growth market.

DRL's PSAI segment (pharmaceutical services and active ingredients) also promises growth potential; the segment registered a 17 per cent growth during the quarter largely led by India and RoW markets. The cumulative DMF filings as of Dec 09 are 388.

Future growth drivers

Dr Reddy's has a fairly strong pipeline of over 62 new drug applications pending approval by the US FDA (Food and Drug Administration). Of these, 35 are Para IVs and 13 are FTF opportunities. The company expects to launch two limited-competition products in the US in the next financial year — the generic version of GlaxoSmithKline's antithrombotic drug Arixtra (expected in FY11) and a generic version of Sanofi-Aventis's Allegra-D 24 (expected in first quarter FY11, $120 million market size). In addition to this, the management has guided for at least one high-value (low-competition) opportunity every year for the next 5 years.

DRL's marketing alliance with GSK is expected to launch its first set of products in Mexico in the April-June quarter. Though the alliance may take two-three years to become a significant revenue spinner, it will help DRL spread its wings in markets it otherwise has little presence in.

Concerns

Betapharm, however, may continue to be a drag on the company's earnings. The change to a tender-based model in Germany has pressured its profitability, forcing DRL to take non-cash hits on intangible assets and goodwill. The carry-forward value of intangibles for Betapharm has now reduced to €93 million (acquisition price €480 million in Feb 2006).

While the management does not expect any further fall in the value of its brands, it has not completely ruled out the possibility either. Any further impairment of intangibles, therefore, would pose a risk to earnings. Delays in the launch of products also pose a risk to expected earnings.

via BL