Margin pressures, growth triggers to weigh on Dr Reddy's Laboratories

Pharma major Dr Reddy’s Laboratories delivered a muted operational performance in the fourth quarter of financial year 2024-25 (Q4FY25), even as revenue growth remained healthy. Lower gross margin performance and muted domestic growth are key concerns. Most brokerages have a “Sell” or “Reduce” rating as there are uncertainties related to the development of a new product portfolio and the launch timelines.

 

The stock has been an underperformer compared to peers not only in the short term (three months, and six months) but also in the longer term. While the peer index, Nifty Pharma, has delivered a 70 per cent return over the past two years, the drug major’s returns are at 20 per cent.

 

Near-term disappointment has been the margin performance in Q4. Gross margins were down 262 basis points (bps) sequentially, and over 400 bps compared to the year-ago quarter. This is the third consecutive fall in gross margins for Dr Reddy’s.

 

Shashank Krishnakumar and Bhavya Gandhi of Emkay Research point out that the sharp sequential decline in gross margins validates their concern since Q2FY25 that gross margin might be on a secular downward trajectory. 

 

While the gross margin decline in Q4 was partly attributed to one-offs, the weakness is also a function of incremental pricing pressures in the core US portfolio, particularly the generic version of Subroxone (for opioid use disorder), the largest contributor after generic variant of cancer drug Revlimid. The brokerage has a “Reduce” rating, with a target price of ₹1,050.

 

Its ability to maintain growth engines, given the impending dip in Revlimid sales (patent expiry in January 2026), is another key worry and will remain an overhang. After a lacklustre approval rate for key drugs in the last five years, the company is eyeing over 20 major launches in the US market over the next four years. Gaurav Tinani of Antique Stock Broking believes that the company has a tough transition ahead as it is in the early stages of a growth rebuild, aiming to counter the anticipated decline in Revlimid sales. 

 

This transition involves navigating the complexities of development, timeline uncertainties for market formation for limited competition biosimilar opportunities, and higher associated costs. The brokerage estimates operating profit margin to be 22.3 per cent for FY27, compared to the management's target of 25 per cent. It has maintained a “Sell” rating on the stock, with a target price of ₹1,025.

 

Growth in the domestic market will be another concern area. The company’s India business revenue grew by 16 per cent year-on-year (Y-o-Y), largely driven by the vaccine portfolio inlicensed from Sanofi, new product launches, and price increases. This was partially offset by lower volumes.

 

Excluding the Sanofi portfolio, domestic sales grew by just 6 per cent in the quarter due to headwinds in cardiac and gastrointestinal therapies. Analysts led by Alankar Garude of Kotak Institutional Equities pointed out that the company’s domestic sales have demonstrated a seemingly healthy 10.5 per cent growth annually over FY17-FY24. However, adjusted for inlicensing, acquisitions and divestments, Dr Reddy’s like-for-like organic domestic sales over FY17-FY24 is merely 7.5 per cent, they added.

 

The brokerage has a “Reduce” rating, with a target price of ₹1,180. At current market prices, they believe the US pricing stability, upside in emerging markets from blood sugar-control formulation GLP-1 or glucagon-like peptide-1, and healthy growth in the EU are priced in.