Q3, FDA action near-term triggers for Dr Reddy's

Stock has shed about 30% in three months, with market cap dropping below Rs 50,000 cr on Thursday

Dr Reddy’s Laboratories has hit 52-week lows on the impact of regulatory action as well as muted expectations from results of the quarter ended December. While other pharmaceutical companies (Sun, Cadila), too, have been at the wrong end of the US Food and Drug Administration (US FDA)’s action, the stock of Dr Reddy’s has corrected the most,  shedding nearly a third of its market capitalsation over the past three months. The warning letters against Dr Reddy’s were issued for its facilities in Srikakulam, Visakhapatnam and Miryalaguda in Andhra Pradesh and Telangana. The company has responded to the US FDA last month and the Street will keep an eye on the outcome.

The immediate trigger for the stock would be the results in the December quarter. While the US FDA action might not have an immediate impact on the company’s US revenues in Q3, financial year 2016 (FY16), overall revenue growth will be restricted to lower single digits. This is due to moderate US growth as the company had to withdraw the generic version of the heartburn drug Nexium in November. The company relaunched the drug at the end of December after changing the colour of the capsule. There have been no significant approvals in recent quarters as compared to peers such as Aurobindo and Lupin. The US is the largest market for the company, accounting for about 48 per cent of revenues. Given the sharp decline in the rouble, which is down 22 per cent year-on-year (y-o-y), its Russian business revenues are expected to be impacted.

In the domestic market, the company has been outperforming the average pharma growth in the quarter. Domestic formulation revenues are expected to grow by 29 per cent because of delayed despatches from the September quarter and benefit of the drug portfolio of UCB which it acquired for Rs 800 crore in April.

The Street has a mixed view on the stock. Some analysts say investors should tread with caution as any adverse action by the US FDA could lead to further correction. However, others contend that in a worst case scenario (Import Alert) only 10-12 per cent of its revenues are at risk, while the stock has corrected over 30 per cent and, thus, there is too much pessimism. Of the 46 analysts tracking the stock, 40 per cent have a buy on the stock while 20 per cent have a sell. The average one year forward target price is at Rs 3,725, which from the current price indicates a return of 28 per cent.