Dr Reddy’s Laboratories: Buy

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,Europe 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 strengthen the case for investing in the stock. At the current market price of Rs 701, the stock trades at a somewhat high valuation of about 14 times its likely FY-10 per share earnings.
Dr Reddy’s has a fairly strong pipeline of over 68 new drug applications pending approvals by the US FDA, 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 $360 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 and not prescription-based.

However, since the formulation patent expires only in 2016, it leaves DRL with sufficient time to capitalise on this business opportunity.

Sumatriptan sales, which had pepped up the revenues significantly since its Nov ‘07 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 ‘10, by when DRL is slated to lose its exclusivity. This may lead to a decline in the company’s operating performance.

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 14 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 71 per cent of the revenue growth.

Overall, revenues from Russia registered a 41 per cent growth in FY-09. The management expects to maintain a healthy growth rate this year. However, excessive forex fluctuations can play spoilsport.

Concerns over DRL’s German arm appear to be on the wane, with Betapharm securing 23 contracts with German health insurer, AOK. Its contracts make up 18 per cent of the overall volumes awarded by the insurer.

For FY-09, the company recorded a one-time non-cash impairment loss with respect to intangible assets (Rs 326 crore) and goodwill (Rs 1,185 crore) in its German business, driven primarily by the shift in market dynamics towards tender-based supply model, characterised by decrease in market prices.

For FY-09, DRL’s sales growth in India remained muted at 6 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.