Dr. Reddy’s Laboratories Ltd
(BSE Code: 500124) (CMP: Rs.1982.90) (FV: Rs.5) By Bikshapathi Thota
Dr. Reddy’s Laboratories Ltd (Dr. Reddy’s) commenced its generics business in India in 1986 and is today a trusted name in the healthcare industry serving millions of patients with high quality, affordable and innovative medicines across the globe. Over the years, the company has significantly grown its product portfolio across mass and speciality therapies. Its portfolio comprises over 200 products covering the whole spectrum of disease areas spanning gastroenterology, oncology, pain management, cardiovascular, dermatology, urology, nephrology, rheumatology and diabetes. 7 of its brands are listed in the ‘ Top-300’ in the Indian pharma market. Its 5,000-member strong team network connects with more than 3,00,000 doctors regularly to ensure the supply of quality medicines. A major share of its managerial vacancies is filled internally. Its field force of 3,500+ is deployed across the length and breadth of the country.
The company has progressively transitioned from being a maker of molecules to a provider of medicines. Its ‘Purple Health’ initiative aims at taking patient-care beyond the pill while focusing on the following areas - Disease awareness and convenient diagnosis; Access to medicines; Better therapy experience; and Adherence to therapy. Dr. Reddy’s reported a weak set of numbers for Q1FY18. It posted 3% higher revenue while EBITDA and adjusted PAT declined 19% and 53% YoY respectively. Operating margins declined to 9% - partially (~20%) owing to channel destocking in the domestic market and a major part (80%) due to the tectonic shift in the US market where channel consolidation and intensifying competition are creating a havoc. The company is finding it difficult to quickly adjust its cost structure to this changing reality. Further, regulatory issues had hampered new launches whereas erosion in the base business due to intensified competition led to a major decline in profitability, which was true for all other generic companies as well.
Ailing US operations, which continued to hurt the base business of its US operations (45% of the total), grew by just 1% YoY and 2%
QoQ (in CC) due to high competition and pricing pressure in key products. gVidaza and gValcyte declined sequentially by $11 mn due to price erosion. India operations (14% of total) were down
10% YoY impacted by channel destocking on transition to the GST regime. Russia operations (13% of total) jumped 48% YoY as the company supplied Rituximab tenders. Gross margin plummeted by
464 bps YoY (up 40 bps QoQ to 51.6%) due to delays in key launches and monetization.
The company expects >10 US launches during FY18. While its pipeline could spring positive surprises, approval delays could derail near-term US revenue build up, which hinges on a number of approvals with complex approval pathways (gLovenox, gPentasa and gDiprivan). In gCopaxone, the company responded to the characterisation issue in DMF (Drug Master File) in December 2016 and has TAD for November 2017. It has responded to the CRL for gNuvaring and has a TAD for Q4FY18. We have built in a best case scenario (H2FY19) in our estimates. But the launch delays imply ~20% downside to FY19 estimates.
We feel that the company’s strong presence and management skills will help succeed in the current situation. Last year, it bought 51 lakh shares at Rs.3090/share and spent Rs.1560 crore in the Buyback scheme and it’s not ruled out that it will do so again to protect shareholders’ value. Considering all these factors, we recommend this stock for a price target of Rs.3000 (25x to FY19E earnings) in the next 12-18 months.