Stock Review: Dr Reddy’s Laboratories (DRL)

 

 

Considering Dr Reddy's robust product pipeline in the US and a strong presence in India,Russia & CIS markets,long-term investors can bet on it

 

   AFTER reporting a dismal performance for the past twothree years Dr Reddy's Laboratories (DRL) is back on the recovery path. The drug maker's impressive June quarter numbers support this fact. It has a robust product pipeline in the US and a strong presence in India, Russia and CIS markets. Given this, investors can bet on this stock with a time period of two years.

BUSINESS:

Dr Reddy's is a global drugmaker focused on active pharmaceutical ingredients (API) & custom services, generics (branded and unbranded) and proprietary products. The company has presence in regulated markets such as US, UK, Germany, and in emerging markets, including India, Russia and CIS countries. It earlier acquired Betapharm in Germany to strengthen its foothold in the EU market. The company's R&D is focused in the areas of cancer, diabetes, cardiovascular, inflammation and bacterial infections. It is the global leader in DMF filings with 375 global DMFs as on March 2010.

GROWTH DRIVERS:


• US markets: Revenue share from the US dropped from 40% in FY09 to 34% in FY10 due to a delay in exclusivity and launches . However, the situation is likely to change given a strong pipeline with 133 abbreviated new drug applications (ANDAs). The company will launch a couple of para-IV products and generics of Lotrel and Prevacid in the US in the second half of the year, boosting its sales in the period. Further, the company will also launch around 15 new products in FY12E.

• Indian markets: Pace of growth in sales in the domestic market has been impressive. In the September 2010 quarter, the company's sales grew 25% from 16% in the first quarter. This is mainly due to the launches of new products in the past one year. The company plans to further penetrate into tier II and tier III cities and also boost sales force in these regions. Besides, the company aims at a growth of 18-20% in the domestic market.

• Russia and CIS: Even in Russia and CIS markets,it is clocking good growth. Management says the reference-pricing rule in Russia will not affect its revenues much. In the September 2010 quarter, the company reported a 17% y-o-y growth in Russia. Its sales are insulated from reference pricing rule and are expected to be better than market estimations.

PARTNERSHIP WITH GSK:

Dr. Reddy's has entered into a strategic partnership with GlaxoSmithKline (GSK) to develop and market select products across emerging markets outside India. This partnership will expand the company's reach in emerging economies and leverage its product portfolio and process development strengths across generic and differentiated formulations. The products will be manufactured by Dr Reddy's and will be licensed and supplied to GSK in markets, such as Latin America, Africa, the Middle East and Asia Pacific excluding India.

FINANCIALS:

In the past couple of years, the financial performance of the company has not been so impressive mainly due to its acquisition of Betapharm in Germany and product recalls and slow ramp up in new products in the US. However, Dr. Reddy's dependence on Betapharm has reduced significantly. It has earlier written down intangible assets and goodwill related to this operation. The company's balance sheet has been effectively cleansed of intangible and goodwill on account of Betapharm. With cost and organisational restructuring and much greater supply chain from India, Betapharm will do better in future.

   The company's operating margin and net profit margin have been improving gradually. After posting an operating loss in the December 2009 quarter, it has reported gradual improvement at the operating level in the subsequent quarters. The return on capital employed (ROCE) also increased to 17% in FY10 from 14% in FY09.

   This increase is attributed to core business growth in India, Russia and North America, rationalisation of business model, cost optimisation and restructuring initiatives. The management has further guided for an ROCE of around 20% for FY11 with a goal reaching 25% by 2012-13. The debt-equity ratio of the company is 0.1, a healthy sign indicating scope to raise capital for future expansions.

VALUATIONS:

Currently, the stock is trading at a price-to-earning multiple (P/E) of 56. Its peers, such as Glenmark Pharmaceuticals and Ranbaxy, are trading at 18.7 and 12.4, respectively. The wide gap in valuations of Dr Reddy's stock and that of its peers is because the former had posted a net loss in the two out of last four quarters. With the expectation of a robust growth in the US, Russia, CIS and domestic markets and visibility in future earnings, the stock seems fairly valued. Investors can consider buying the stock.