Firm Call. Why Dr Reddy's is set for a rebound

After putting up a subdued performance in recent years, many Indian pharma companies have reported an improved set of numbers in recent quarters, thanks to subsiding price pressure in the US business, and better traction in domestic as well as emerging markets. The prospects for revenue growth seem particularly healthy for a few pharma companies which have diversified exposure across geographies and are growing their presence in niche speciality and limited-competition drugs.

Dr Reddy’s Laboratories is one such pharma player that seems set for a rebound from the subdued performance from 2015 to 2018. Over the past five quarters, it has registered a sequential improvement in its revenue and earnings, driven by growth in its business in India, Russia and emerging markets, and active pharmaceutical ingredient (API) products.

Having resolved the regulatory issues at most of its key facilities, Dr Reddy’s is now expected to ramp up its performance further, led by approvals in the US, new launches and product-level cost optimisation. The company’s focus on biosimilars, along with its foray into the Chinese generic market, will further improve its profitability.

Over the past two years, divestment of non-core assets, trimming of the workforce and rationalisation of R&D have led to an improvement in margins and return ratios of the company.

Investors with a long-term horizon can consider buying the stock.

At the current price of ₹2,864, the stock trades at about 19.3 times its estimated 2020-21 earnings, which is lower than that of Lupin’s (22 times) and comparable to peers such as Sun Pharmaceutical Industries and Cipla (19 times and 18 times, respectively).

In the second quarter of 2019-20, Dr Reddy’s consolidated net sales were ₹4,801 crore, up 26 per cent over the same period last year. The consolidated net profit was ₹1,093 crore, up 117 per cent y-o-y. The growth during the quarter was attributed to the receipt of a one-time licence payment for selling the US and select territory rights for two of the company’s neurology brands.

The firm’s business growth in the US during the quarter was flat due to company-specific logistic issues, the recall of Ranitidine and pricing pressure (though moderated from earlier).

But its Europe and emerging- market businesses registered a significant growth of 40 per cent and 10 per cent y-o-y, respectively. The firm’s domestic market business grew 9 per cent y-o-y; operating margin was at 30 per cent.

Recovery in US business

Dr Reddy’s US business, which contributes 30 per cent to the total revenue, has been under trouble over the last few years due to regulatory tightening and price erosion in key drugs.

The pricing pressure is likely to subside going ahead, given its low product-revenue concentration and new launches of complex and limited-competition products.

Its US business is well-positioned for growth from a healthy pipeline in the medium- to-long term, with niche generic launches, including Suboxone, Copaxone and NuvaRing.

The company has been one of the best Para IV ANDA (abbreviated new drug application) filing entities in the industry (The company first submits an application for generic approval which is usually eligible for the exclusive right to market the generic drug for 180 days if approved). Of the 96 pending ANDAs, 55 are Para IV filings and 31 have FTF (first to file) status.

In the near term, limited-competition products such as Copaxone and NuvaRing, which has been long pending for approval, are expected to generate significant revenue for the company, once launched.

The management expects 30-plus launches in FY20 to be on track, of which 13 have already been launched in the first half of FY20.

Some of the other potential launches in FY21 include Cubicin, Remodulin, Treanda, Sensipar, Dexilant and Kuvan.

Strong domestic market

Dr Reddy’s domestic business, which contributes 16 per cent to the total revenue, has been growing strongly, driven by new launches and high volume growth in existing products.

The company has guided for 25-40 launches in FY20 in areas including oncology, nutraceuticals and OTC (over-the-counter).

Recent launches such as Hervycta and Clohex ADS have registered significant traction in sales. Around 20 per cent of its domestic portfolio is under the NLEM (National List of Essential Medicines) price- control list.

Opportunities

The business from emerging markets, including Russia, CIS (Commonwealth of Independent States), Brazil and China (representing 20 per cent of the total revenue) has shown strong traction in recent quarters.

The business from the emerging markets is expected to be strong going ahead, on the back of a stabilising currency, geographical expansion, a robust biological portfolio and a ramp-up in institutional business. In Russia, Dr Reddy’s expects a healthy performance from the tender-driven biosimilar business.

Dr Reddy’s is the first Indian drugmaker to win an approval to supply a key drug to treat schizophrenia and bipolar disorder in China. The company has won the tender to market Olanzapine drug in China, which is expected to launch in the beginning of next year. Olanzapine is estimated to be a $200-million market opportunity (per annum). The company has plans to launch over 70 products in the country. China could be a significant revenue contributor to the company’s overall revenue in future.

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