Dr Reddy's: Q3 results, USFDA near-term triggers

Dr Reddy's Laboratories has been hitting 52-week lows on the impact of regulatory action as well as muted expectations from December quarter results. While other pharma companies (Sun, Cadila) too have been at the wrong end of the USFDA action, the stock of Dr Reddy's has corrected the most shedding nearly a third of its market capitalsation over the last 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 USFDA 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 USFDA action may not have an immediate impact on the company's US revenues in Q3, FY16, overall revenue growth will be restricted to lower single digits. This is due to moderate US growth as the company had to withdraw 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 for the company in recent quarters as compared to peers such as Aurobindo and Lupin. US is the largest market for the company accounting for about 48 per cent of revenues. Given the sharp decline in the rouble down 22 per cent year on year, its Russian business revenues are expected to be impacted in the quarter.

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

The Street has a mixed view on the stock. Some analysts say that investors should tread with caution as any adverse action on the USFDA front could lead to a further correction. However, others contend that in a worst case scenario 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.