A dose of concern for DRL: Sinks 5% on USFDA 'imminent' warning

Sell-off in response to a brokerage report, raising concerns about a warning on DRL's FTO 3

Shares of Dr Reddy’s Laboratories (DRL) fell 5 per cent to Rs 5,473 on the BSE in Monday’s intraday trade, nearly wiping out the past month’s entire gain of 6 per cent.

The sell-off was a reaction to a report by Antique Stock Broking, which flagged an ‘imminent’ warning letter from the US drug regulator on DRL’s Formulation Technical Operation Unit 3 in Bachupally suburb (in the Medchal-Malkajgiri district) of Telangana.

The research and broking house has maintained its ‘sell’ rating on the stock in its report on Monday with a target price of Rs 4,766, a downside of 13 per cent over Friday’s closing.

The formulation manufacturing unit, according to analysts, is significant for the company as it contributes 30 per cent to the drugmaker’s US revenue and manufactures four of DRL’s top 10 products, including generics of Ciprodex (antibiotic ear drops), Nexium (for stomach ulcers or acid reflux), Valcyte (anti-infective during organ transplants), and Toprol (a beta-blocker to treat angina and high blood pressure).

Any adverse regulatory outcome due to this is likely to withhold future approvals from this unit, they observe.

The inspection of the unit dates back to a routine current good manufacturing practice (GMP) inspection carried out between October 19 and October 27 at DRL’s formulation manufacturing facility, which resulted in the plant receiving a Form 483 with 10 observations from the US Food and Drug Administration (FDA).

In a separate development, DRL on Friday was issued a Form 483 with three observations after a GMP and pre-approval inspection conducted from December 4-8 at its research and development centre in Bachupally.

An FDA 483 observation is a notice that highlights potential regulatory problems.

Under the lens

In their report on Monday, analysts Monish Shah and Pranav Chawla of Antique Stock Broking said they analysed the 10 observations dating back to October 2023, seven of which are severe, about quality control, faulty equipment, and data integrity.

Given the severity of these, they believe there is a high likelihood of the site getting a warning letter.

Typically, a warning letter is issued for voluntary and prompt corrective action before the regulator initiates an enforcement action. Warning letters are issued only for violations of regulatory significance but do not lead to product bans.

Limited upside

The current stock price, the brokerage adds, has largely priced in current and coming opportunities in the US and has limited upside.

In late October, analysts at Prabhudas Lilladher raised 2023-24/2024-25 earnings per share estimates by 13.5 per cent/7.6 per cent, aided by higher Revlimid (used to treat multiple myeloma) sales, noting moderate base or core business profitability and holding their ‘reduce’ rating.

In the July-September quarter of 2023-24, DRL posted a 2 per cent quarterly decline in US sales to $382 million, impacted by weakness in the base business.

Market share in base products like generics of Vascepa (to lower blood triglyceride levels) and Ciprodex has likely stagnated, and DRL is facing stiff competition in Lexiscan (for cardiac nuclear stress test) and Remodulin (a vasodilator), noted analysts at Axis Securities in their October report.

Its India business continued to struggle in the recently concluded quarter at 3 per cent year-on-year, with subpar growth in the India pharmaceutical market.

This subpar growth, analysts said, was due to a weak ‘acute disease season’ and price reduction under the National List of Essential Medicines.

DRL draws 46 per cent of its business from North America, 18 per cent from emerging markets and 17 per cent from India. An uptick in the core US portfolio remains a key upside risk for the stock, analysts said.