Dr Reddy's: Multiple growth opportunities, re-rating likely

Launches from R&D portfolio could be a medium-term trigger; recent buy will boost domestic growth

Dr Reddy’s Laboratories was an underperformer in the pharmaceutical space over the past year. This was on the back of slower growth in the domestic market, currency volatility in the CIS region and regulatory uncertainty. Analysts say the company’s investments in its research and development (R&D) pipeline, including biosimilars and niche/limited competition products for the US market, should pay dividends. Despite the recent run-up (10 per cent up in April), valuations are supportive as the stock is trading at 18 times its FY17 earnings, which is at a 10 per cent discount to peers.

On R&D, the company recently filed three new drug applications with the US Food and Drug Administration. These drugs are part of its proprietary product group, focused on developing therapies in dermatology and neurology.

  A key worry for investors has been the low visibility/results from the R&D spend at 10-11 per cent of sales, among the highest in the pharma space. Given the recent launches, some fears are likely to be allayed. The recent filings, according to analysts at Barclays, can translate into launches from FY17 onwards, with revenue potential of $30-$100 million for each filing, while the entire segment could be worth $500 million over the next five years. Within the R&D spend, about 20 per cent is on biosimilar products and given the start of the approval process in the regulated markets (US), the  biosimilar pipeline, considered by analysts to be ahead of its pharma peers, could come into play in the medium term.

Further details about its full R&D pipeline is expected to be announced by the management in May, which analysts say will lead to a re-rating of the stock as the Street starts to give appropriate valuations to its innovative drugs.

Meanwhile, the company's domestic segment, which is improving, would be bolstered by it's recent acquisition of select brands of UCB in the respiratory, dermatological and paediatrics segments. The Rs 800-crore price at enterprise value/sales of 5.3 times is in line with recent acquisitions and should boost the company's respiratory portfolio in the cough, cold and allergy segments. Overall, profitability should also improve, given the higher margins of the acquired products compared to the current Indian operations. Given the recovery in domestic pharma, India revenue growth in FY15 is pegged at 13 per cent, compared with eight per cent in FY14.

In the near term, some of  challenges, especially on the emerging markets, are likely to remain. Given the sharp fall in currencies against the dollar, the March quarter results could suffer, given the 40 per cent decline in currency values. What will drive overall revenues are the gains on a sequential basis in the US market from higher proportion of anti-viral drug Valcyte, supported by growth in its niche product portfolio of cancer medications Vidaza and Dacogen, and epilepsy formulation Divalproex.