DLR's downhill road

SMARTSHARE

Between 2001-2004, Dr Reddy's Laboratories (DRL) was consistently among the best performing stocks listed on the NYSE. Before that, it had been a star performer on the Indian bourses since the early 1990s. In the last 18 months, things have changed.

Through the good years, DRL was hailed by financial analysts as a classic example of a research-driven company that had successfully leveraged the competitive advantages of excellent research skills and relatively low costs to grow quickly.

Like most Indian pharma outfits, it started life as a "reverse-engineer" and profited from India's process-patent laws to find cheaper, more efficient ways of making popular drugs.

As India shifted over to a WTO-compliant patent regime that recognised product-patents rather than process-patents, DRL was one of the few Indian companies that was quietly confident.

It believed it had the research skills and the nous to compete with the Pfizers and GSKs. It had networked hard to build its marketing structure abroad and fought international legal cases. So, it understood the gladiatorial system of challenges it would face in targeting those markets.

That faith has not yet translated into results. Financially, 2003-04 ended weakly and 2004-05 was disastrous. DRL has not had a big generics release in its export markets for over three years and its existing portfolio is facing price pressure.

According to the CEO, "Our key products of fluoxetine and tizanidine in the US as well as ramipril in Europe witnessed significant competition, resulting in a decline in revenue with no offsetting new products."

Domestically speaking, the drug-pricing changes due to VAT and DPCO policy changes meant an inevitable slowdown across the entire Indian pharma industry's offtake in Q4, 2004-05.

The Hyderabad-based company declared a January-March 2005 net loss of Rs 51.9 crore, compared to a profit of Rs 16.2 crore in Q4, 2004-05. The Q4 revenues dropped to Rs 425 crore from Rs 476 crore a year earlier. The market had expected a poor performance but this was even worse than consensus expectations, which were around Rs 450 crore revenues and Rs 8-10 crore net.

The full year performance was also disheartening. In 2004-05, DRL's net profit declined 91 per cent to Rs 21.1 crore from an NP of Rs 247.4 crore in 2003-04. The total revenue in 2004-05 was Rs 1,947.2 crore, a 3 per cent decline from Rs 2,008.1 crore revenue in 2003-4.

The stock's trading at Rs 650 on the NSE, a 53 per cent drop from the Rs 1,400 level it was trading at in January 2004. In comparison, the Nifty, of which it is a component, has moved from 1850 levels to 1985, a gain of 7.3 per cent. At current levels, PE is an astronomical 235.

This is serious. DRl will almost certainly recover at some stage. It is doing the right things in terms of imposing more stringent cost controls, eyeing strategic acquisitions abroad, more directed research etc. At some stage, it will find profitable new generics releases and ramp up revenues.

But things could get worse before they get better. Market estimates are that 2005-06 and 2006-07 could also be weak. At least one leading brokerage has a price target of 525 "" it's expecting a drop of 20 per cent from current price.