Tempered hopes for Dr Reddy's

Key trigger outcome of US audit at Srikakulam facility

Dr Reddy's Laboratories stock fell five per cent on Thursday and hit its 52-week low on worries that resolution of US regulatory issues could get pushed out to FY19. The Street was expecting issues to get resolved in FY18 after the US had issued warning letter in November 2015 to Dr Reddy's three facilities at Miryalaguda, (Telangana), Srikakulam, and Visakhapatnam (the last two in Andhra Pradesh). 

On Wednesday, the US regulator listed 13 observations on the company's Visakhapatnam plant.

The exact details are not known. The plant is not a major earnings contributor. But key products that could see launch delays are cancer drugs Gleevec and Melphelan. Dr Reddy's has already initiated transfer of some key products from the facility. 

Last month, the US had issued three observations to its Miryalaguda facility. Though the unit accounts for less than five per cent of revenue, observations are a negative, given its implications for the other two facilities. Given the time-intensive nature of resolution, it could take anywhere between three and nine months for the warning letter to get withdrawn. 

The near-term trigger for the company would be the completion of US audit of its Srikakulam facility and any comment by the US. The Srikakulam audit is key as it is the largest Active Pharmaceutical Ingredient facility for Dr Reddy's and accounts for 15 per cent of revenues, say analysts at Jefferies. 

The bad news for Dr Reddy's is not limited to its manufacturing plants but also to its ongoing cases in US courts. Last month, the company received an unfavourable ruling on the generic (or copy) of anti-nausea drug Alozi. If the company had won the case, it would have been the only player with a right to market the product for six months. Analysts had factored in a positive ruling and total sales of $140 million over FY18 and FY19. 

Recent events, coupled with pricing pressure on its US portfolio, will cap revenue and profit expectations. Analysts believe that stock valuation at 21 times the firm's FY19 estimated net profit is at a premium to bigger peers. Analysts at Nirmal Bang have reduced their stock valuation to 18 times from 21 times, given US pricing pressures and US regulatory issues for its facilities.