Dr Reddy's: Multiple growth opportunities, re-rating likely

Dr Reddy's Laboratories has been one of the underperformers in the pharmaceutical space in the past year. This was on the back of slower growth in the domestic market, currency volatility in the CIS region and regulatory uncertainty. Going ahead, analysts say the company's investments in its R&D pipeline including biosimilars as well as niche/limited competition products for the US market should pay dividends. Despite the recent run-up (10% up in April), valuations are supportive as the stock is trading at 18 times its FY17 earnings, which is at a 10% discount to peers.

On the research and development (R&D) front, the company recently filed three new drug applications with the US Food and Drug Administration (USFDA). These drugs are part of its proprietary product group focused on developing therapies in dermatology and neurology. One of the key worries for investors has been the high R&D spend for Dr Reddy's (10-11% of sales) the highest in the large cap pharma space without quantifiable results. Given the recent launches ,some of the fears are likely to be allayed.

The recent filings, according to analysts at Barclays, can translate into launches from FY17 onwards with revenue potential of $30-$100 million for each filing while the entire segment could be worth $500 million over the next five years. Within the R&D spend, about 20% is on biosimilar products and given the start of the approval process in the regulated markets (US), the company's biosimilar pipeline, considered by analysts to be best among Indian pharma companies, could come into play.

Further details about its full R&D pipeline is expected to be announced by the management in May, which analysts say will lead to a rerating of the stock as the Street starts to give appropriate valuations to its innovative drugs.

Meanwhile, the company's domestic segment, which is improving, would be bolstered by it's recent acquisition of select brands of UCB in the respiratory, dermatological and paediatrics segments. The ~800-crore price at enterprise value/sales of 5.3 times is in line with recent acquisitions and should boost the company's respiratory portfolio in the cough, cold and allergy segments. Overall, the profitability should also improve given the higher margins of the acquired products compared to the current Indian operations. The company has indicated that sales growth from the domestic market for FY16 is likely to be 20% aided by the launch of over 20 products in the Indian market, which accounts for about 15% of Dr Reddy's revenues.

In the near-term, some of the challenges, especially on the emerging markets front, is likely to remain. Given the sharp fall in currencies against the US dollar, the March quarter results could suffer given the 40% decline in currency values. What will drive overall revenues are the gains on a sequential basis in the US market from higher proportion of anti-viral drug Valcyte supported by growth in its niche product portfolio of cancer medications Vidaza and Dacogen and epilepsy formulation Divalproex.