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Strong outlook for Dr Reddy's scrip

Stock's attractive valuation and firms diversified revenue stream should ensure robust growth in the next few years

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Dr Reddy’s Laboratories’ scrip has been down about eight per cent over the last month on weak results, underperforming its peer index, which has been flat, and the broader Sensex, which has gained 3.5 per cent.

While this fall is part of the stock’s underperformance starting April this year, partly on account of investors moving away from defensives to riskier assets as well as some profit booking, news flow for the company has been positive in the last week. More importantly, the future prospects remain robust and stock valuations at current levels of Rs 1,573 are attractive.

Among recent news, the company last Wednesday announced a tie-up with Merck Serono, part of German multinational Merck KGaA, to develop and market biosimilars world-wide. Though drugs in this category are worth only $500 million now, they are likely to reach $4 billion by 2015 after patents on key drugs expire and more clarity on approvals emerges, say analysts. Second, in the near future, the company is expected to get approval to launch the low-cost version of cholesterol-lowering drug, Lipitor, which will add to revenues.

  FY12 FY13E
Revenues (Rs cr)  9,673 12,047
% change* 29.5 24.5
Ebitda (Rs cr) 2,541 2,606
% change* 54.8 2.6
Ebidta (%) 26.3 22.0
Net profit(Rs cr)  1,426 1,741
% change* 29.2 22.1
P/E (x) 18.5 15.2
E: Estimates                                  * % change is y-o-y
Source: Company, analyst reports 

On the whole, the company is expected to clock revenue growth of 30 per cent in FY13 after crossing the $2-billion mark in FY12, which instills confidence. Given its strong performance in the US, large pipeline and streams such as biosimilars, analysts are bullish about the company’s prospects. Balaji Prasad and Edward J Dulac III of Barclays Research are overweight on the company, on the back of a robust US pipeline, operating fundamentals and returns, which are further expected to improve. On the valuations front, the stock is at an attractive 15 times one-year forward earnings, which is at a 15 per cent discount to the sector, as well as its one-year forward average price-earning of 20 times.

Biosimilar deal
The company’s agreement with the Merck arm will not only help share a small portfolio of the cost of drug development, but also help in marketing these in various geographies. While the company currently has four biosimilar drugs generating about Rs 125 crore, analysts expect the revenue to scale up to Rs 500 crore over the next three years as its portfolio grows. Dr Reddy's has about eight products in various stages of development and commercialisation. However, it will take three years before the company can reap gains from the new drugs. IIFL analysts are bullish on biosimilar growth prospects as these are more complicated to make and the price erosion on the drugs is likely to be 25-50 per cent, unlike generic drugs, where it is usually over 70-90 per cent.

Strong US portfolio
Analysts expect Dr Reddy’s’ US business (37 per cent of the overall revenue) to grow at 18-20 per cent annually for FY12-FY14, aided by its portfolio, that includes a pipeline of 80 pending ANDAs (abbreviated new drug applications). For the current fiscal, the company will depend on sales from launch of generic versions of anti-coagulant Plavix and for which it is awaiting US Food and Drug Administration’s approval. The company will also look to improve its market position in products already launched such as Arixtra, an anti-coagulant.

In the US, the company has also been focusing on limited competition products, which has helped it garner revenues of $200 million, equivalent to 10 per cent of its overall revenues. While there are good opportunities in this space, revenue growth could be a bit erratic, say analysts.

Europe concerns persist
The biggest worry for the company continues to be its German business, Betapharm. While the overall revenue growth in FY12 for the company was 30 per cent, its European business (less than 10 per cent of overall revenue) declined two per cent. The German business, which constitutes 60 per cent of European sales, continues to suffer from a decline in tender prices. The company is likely to depend upon launches in the rest of Europe, which grew eight per cent in FY12, to boost growth.

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