1. Kotak puts ‘Sell’ rating on Dr Reddy’s Laboratories; here’s why

Kotak puts ‘Sell’ rating on Dr Reddy’s Laboratories; here’s why

While the stock’s re-rated on account of hopes on several fronts, the pipeline isn’t sufficient to offset competitive pressures on the US biz.

By: | New Delhi | Updated: October 1, 2016 7:05 AM
dr reddy's labs shares Following the sharp correction after weak Q1FY17 results, DRRD shares have re-rated by ~10% on hopes of earnings accretion from Teva portfolio acquisition, particularly from the likely launch of Nuvaring in FY2018, resolution of FDA issues towards the end of FY2017(Reuters)

DRRD shares re-rated by 10% post Q1FY17 correction on hopes of earnings accretion from Teva portfolio acquisition, particularly from the likely launch of Nuvaring in FY2018, resolution of FDA issues towards the end of FY2017, and expected pickup in US launches from 2HFY17. Teva deal adds to growth, but we do not believe the pipeline is sufficient to offset competitive pressures on the US business for FY2017/18. Sell.

Stock price resilient, but pressure points remain

Following the sharp correction after weak Q1FY17 results, DRRD shares have re-rated by ~10% on hopes of earnings accretion from Teva portfolio acquisition, particularly from the likely launch of Nuvaring in FY2018, resolution of FDA issues towards the end of FY2017, and expected pick up in US launches from 2HFY17. DRRD’s 1QFY17 US performance was a validation of our thesis of incremental pricing pressure in the US, with significant cuts expected to “complex” products which have benefitted partly from regulatory inefficiencies. We believe Q1FY17 numbers unmasked the performance of the base business of DRRD, and despite three approvals in Q2FY17, we expect incremental headwinds to hit the US from Q2FY17 due to competitive pressures on Vidaza and Valcyte. We also expect sumatriptan auto-injector to come under pressure in H2FY18 following Teva’s launch in June while fondaparinux and metoprolol XR could also be potentially impacted should Teva and Intas receive approvals in CY2016. We are cautious about decitabine with our checks suggesting at least five filers awaiting approval with Sandoz expected to re-enter in FY2018.

New launches key, though run-rate tepid

To offset these products and stave off competitive pressures, DRRD needs a stream of launches, though FY2018 approvals (NitroStat, Zegerid and Wellbutrin SR) will hardly move the base. In the past, the management guided for back-ended recovery in approval run-rate. However, we see risk of delays, particularly for Aloxi, propofol (likely in FY2018 now), Gleevec and Exelon with the first highly contingent on litigation and the other three dependent on approval. While Nuvaring and Vytorin launches from the Teva portfolio in FY2018 will likely support earnings, we remain cautious on Nuvaring, and do not rule out additional regulatory delays to approval. We also see a high likelihood of Copaxone launch slipping to FY2019.

Hopes high on FDA re-inspection, though lack of pipeline is worrying – Sell

In the past, the management suggested it was almost through with remediation activities and is planning to seek a meeting with the FDA next month, leading to hopes that FDA resolution is likely in FY2017. However, we highlight that FY2018/19 earnings already factor in FDA resolution. At current valuations, DRRD trades at 26X and 22X FY2018E and FY2019E P/E, at 10-12% premium to front-line peers. We tweak our FY2017-19 EPS marginally. Sell.

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