Strong growth in the US market has put the stock of Dr Reddy’s Labs on steroids, with the blue-chip stock soaring 59 per cent in the last one year.
However, with an already high revenue base in the US, the lack of blockbuster products and a sharp jump in the R&D spend, the pharma major may find it difficult to do an encore this year.
The benefits from the R&D investment and capacity addition may also turn out to be back-ended. At its market price of ₹2,786, the stock trades at about 20 times its estimated earnings for 2014-15. Though there’s nothing wrong with the company’s fundamentals, near-term challenges may cap the upside in the stock. Investors can consider selling it.
In 2013-14, the launch of low-competition generic drugs such as azacitidine, decitabine and divalproex ER, price increases and market share gains in some products in the US helped Dr Reddy’s deliver high sales and profit growth. But sustaining the momentum next fiscal may prove challenging for three reasons.
R&D spends For one, the company is stepping up R&D spends. The research and development expense as a proportion of the company’s consolidated revenues has risen from 7.1 per cent in the December 2012 quarter to 8.4 per cent in December 2013 quarter. R&D as a percentage of revenues may rise to double-digit levels in 2014-15. The new investments are being made in developing biologic drugs, complex generics and proprietary products. In addition, the company is also augmenting its manufacturing facilities (chemicals and finished formulations) at a cost of around ₹1,000 crore. Though these investments may pay off in the long term, revenue contributions may be some time away. In the absence of matching revenue, higher costs may temper the company’s profits over the next one to two years.
Two, the company’s current pipeline for the US market lacks large products (in revenue terms), though it has a good number of small products. Given the high revenue base and heightening competition in this geography, sustaining the current growth may not be an easy proposition. Weakness in its pharmaceutical services and active pharma ingredients business, due to lack of major launches, price erosion and inventory rationalisation by clients, also remain challenges.
Three, price cuts in key domestic brands due to implementation of the new drug pricing policy and stiff competition have impacted the company’s growth in the home market.
Efforts such as launch of drugs in the chronic therapy areas are yet to yield results. With India being one of the high-margin geographies, sustaining growth here will be critical to Dr Reddy’s profitability.