 "Is Dr Reddy's a buy on dips?")
Legendary investor Warren Buffet says that one should be fearful when others are greedy and greedy when others are fearful. Though the quote is meant for long term investors, market throws up short term opportunities to capitalise on sudden price aberrations.
A few months back it did in the case of Nestle when the company was asked to withdraw its key product Maggi from the shelves by food regulator FSSAI, only to be cleared shortly. Stock prices fell by 20 per cent in a short time giving a good opportunity for investors to enter. The stock has made a full recovery since then.
A similar opportunity was presented in Dr Reddy’s Laboratories today when the stock was hammered on news that a US law firm Lundin Law PC announced that it is investigating claims against the company concerning possible violations of federal securities laws. The investigation is related to allegations that certain statements issued by Dr Reddy’s were false and misleading concerning the company’s financial performance.
The law firm has requested investors to approach them to join a class action suit against the company.
Dr Reddy’s stock price has been hit over the last two months and touched a nine month low falling 25 per cent from its peak mainly on account of a warning letter it received from the US Food and Drug Administration (US FDA) over quality control issues at three of its manufacturing facilities.
Analysts had downgraded the company post the warning letter. Barclays in a note had mentioned that they expect earnings to be hit to the tune of 10-15 per cent over the next two years on the back of future approvals decelerating, escalating remediation costs and revenue gap as supply is affected, and consequent operating deleverage. According to Dr Reddy’s management, the three facilities together account for 10-15 per cent of its revenues. Barclays added that in the event that the warning letter escalates further to an Import Alert, EPS could be impacted a further 15%.
The warning letter was damaging enough for the stock which fell from highs of Rs 4,379 to a low of Rs 3,253 in a matter of six days.
However, on news of a class action suit being considered the stock fell nearly 7 per cent during the day touching a low of Rs 3,140 but has recovered since and presently trades at Rs 3,320.
Though analysts are bearish on Dr Reddy's Labs post the warning letter, they are backing the company’s management in the present class action suit. Nomura [LINK 2] said that it strongly believes in the financial integrity of the company and recommends investors not to get bogged down by such events. Lundin Law PC has been filing similar law suits against other companies as well. Most stocks have already corrected before law suits were filed against them. Warning letter has got nothing to do with financial integrity of the company, say analysts.
Dr Reddy’s management has said that they have adhered to all disclosure requirements of stock exchanges and refute all charges.
While nothing much might come out from these allegations, it was a good opportunity for short term traders to capitalise on the news. Even as analytical skills are an important pre-requisite for investing, interpreting news and its impact on the stock price helps in taking advantage of such short term blips.
However, unlike Nestle where most of the analysts were positive on the company, in the case of Dr Reddy's, there are many who are cautious. Barclays in its analysis on warning letters to Indian pharmaceutical companies has pointed out that over the past 15 years there is a three phase impact on companies who have been issued warning letters.
In the first phase, which last for one month, stocks tend to correct 10%-15%, excluding any earnings decline. In Phase II, that runs from 1-12 months additional earnings pressure and continuing negative sentiment limits any bounce back, unless the warning letter is lifted. And in the 12-18 months period of Phase III, stocks, especially large caps, recover past multiples and earnings reset. Barclay feels Dr Reddy has entered an uncertain phase and would prefer to wait it out as downside case assuming further regulatory escalations can push the stock to Rs 2,551 levels.
