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Dr Reddy’s Laboratories Rating: Buy; Bid win in China marks a first for company

Event establishes DRRD’s ability to participate in new bidding process in China; leads Indian firms in country; ‘Buy’ retained.

As in the United States, its China sales growth is likely to be uneven as a few key products could have a significant impact on sales, particularly on a low base. Dr Reddy’s is targeting ~70 products in China with a market size of ~$8 bn.
As in the United States, its China sales growth is likely to be uneven as a few key products could have a significant impact on sales, particularly on a low base.

Dr Reddy’s Laboratories is one among the three successful bidders for Olanzapine in the recently held procurement bids for 25 drugs in China. It was one of the 45 companies that were selected to participate in the bids this time. Dr Reddy’s Laboratories (DRRD) is the first Indian company and the second international generic company (after Sandoz) to be selected and successfully participate in the bidding process in China under the Quality Consistency Evaluation (QCE) system.

The successful bid indicates the start of participation of Indian companies in the Chinese generic drug procurement process. China is implementing a nationwide generic drug procurement process through bids in an effort to bring down the cost of drugs. In order to participate in the bids, the generic companies have to successfully conduct bioequivalent studies.

Based on the disclosures made by Hansoh Pharma (3692 HK), we estimate that the Olanzapine market in China was worth ~$400 mn in 2018 and generics have more than 70% market share. For Olanzapine, it is one of the largest products for Dr Reddy’s in China. The company currently has ~10-11% market share and is the third largest player in the market. The market leader Hansoh recorded $250 mn in sales from the product in 2018. In the last trial bids held in 11 cities in China (also referred to as 4+7 GPO bids) in December 2018, Olanzapine prices were cut by the winner Hansoh by ~27%. Media reports suggest that Dr Reddy’s bid was at a 35% discount to the current prevailing price.

We think that at reduced prices, the Olanzapine market is attractive with $200 mn of sales. The gains for

Dr Reddy’s will depend on the quantum of market share gains, which we think should substantially increase from the current levels. The overall revenue gain for DRRD can be $10-30 mn, in our view, depending on the market share gains.

We think more than the financial gains from Olanzapine, the bid win establishes Dr Reddy’s ability to participate in the newly-established bidding process in China. The next big opportunity for Dr Reddy’s is Clopidogrel, for which, we believe, the company may participate in the tender bids in FY20 itself. The company is conducting biostudies to qualify for the tenders. The Clopidogrel market is more than $1 bn in size with most of the market share retained by the innovator Sanofi.

We think Dr Reddy’s Laboratories is ahead among India companies in addressing the China opportunity. Dr Reddy’s Laboratories’ long presence in China has enabled the company to address the opportunity quickly. As in the United States, its China sales growth is likely to be uneven as a few key products could have a significant impact on sales, particularly on a low base. Dr Reddy’s is targeting ~70 products in China with a market size of ~$8 bn.

We have a Buy rating on Dr Reddy’s. We arrive at our target price of Rs 3,284/sh based on sum-of-the-parts (SOTP) valuation. We arrive at Mar-20 value based on: (a) 18x FY21F base EPS (earnings per share) of Rs 161/sh (base EPS excludes the loss from proprietary products business, and (b) product-specific opportunities at Rs 251/sh. We roll over Mar-20 target to Aug-20 at 11% CoE to arrive at our target price of Rs 3,284. The stock is trading at 18.4x FY21F EPS of Rs 151.5.

 

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