Dr. Reddy’s: Ground realities - Views on News from Equitymaster

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Dr. Reddy’s: Ground realities

Jul 27, 2002

Early during the week, Dr. Reddy’s stock fell more than 16% in the intra day movement. This was in reaction to the suspension of clinical trials for its anti-diabetic molecule licensed to Novo Nordisk. This came as a major setback for the company. DRF-2725, the dual acting insulin sensitiser termed as ‘Ragaglitazar’ was amongst the major catalyst for the company’s research efforts. The life cycle of Ragaglitazar:
Ragaglitazar was one of the two anti-diabetic molecules, which were out-licensed to Novo Nordisk in March 1997. Subsequently, Novartis Pharma AG, entered into agreement for commercialization with Novo Nordisk, only to withdraw the tie-up later. The molecule entered into the Phase III trials in November last year creating huge hopes for the company. Had the molecule entered the commercial stage, it would have been the first to reach the market from a new generation dual acting sensitisers globally. It may be mentioned here that Glaxo faced a similar set back in October last year, when its insulin sensitiser was withdrawn from Phase III trials. There are several other drug majors researching on insulin sensitisers including Merck and AstraZenca molecules who are in late Phase II trials.

Best & worst case scenarios:
The side effects of the drug have been observed only on rodent’s species currently and it could be of no relevance to humans. However, for patients’ safety reasons, Novo Nordisk decided to take precautionary approach and has suspended the ongoing clinical trials. Currently, all clinical trials involving Ragaglitazar have been stopped and all planned new clinical trials have been postponed as the side effects on rodent species are being investigated further.

New trials can resume if the data is found to have no human significance. However, the Phase III filings and hence US$ 10 m payment expected to be received by Dr. Reddy’s would be delayed by at least 24 months. In the worst-case scenario, if the data of the studies is found to have human significance, Ragaglitazar compound would be dropped and there would be no further royalty payments for the company.

Ragaglitazar or not, the long-term business prospects of Dr. Reddy’s remain intact. The research spend of the company has been on the rise in the last few years and is expected to continue its momentum going forward. While such disappointments are not uncommon in the international pharma market, it was first of its kind for Indian companies. It is worth reiterating over here that probability of success in pharma research is only one out of several thousand molecules. The incident has atleast brought investors face to face with the risk profile of a research based pharma company.

We had not factored in any revenues (either royalty or milestone) from Ragaglitazar due to uncertainty and hence there is no change in our forward EPS estimates for FY03. It may be recalled that one-time revenues from high margin generic exports of fluoxetine fuelled FY02 financials and hence EPS is slated to register a slide in the current year.

Rs m FY02 FY03E
Net Sales 15,211 15,055
Operating Profits 4,798 3,944
Operating Margins % 31.5% 26.2%
Profit after tax 4,597 3,213
EPS (Rs) 60.1 42.0

Another major catalyst for Dr. Reddy’s is the revenue potential from Para IV product filings, which again is highly uncertain revenue stream. Without any exception, these filings are prone to heavy litigation and the final outcome of this is again difficult to forecast. But on the other hand, there is a huge upside potential if successful.

A case in point here is two Para IV ANDA filings of Prozac (fluoxetine) and Prilosec (Omeprazole). The final approval for generic version of the antidepressant Prozac was massive revenue grosser for the company. For FY02, this single product contributed US$ 67 m (more than 21% of the company’s total turnover), with operating margins in the range of 75-80%. Profits were more than US$ 50 m from this single product as against a total net profit of US$ 30 m in FY01.

On the other hand, the company’s another Para IV filing for Omeprazole, turned out to be a major disappointment. Following withdrawal of its tentative Omeprazole approval, the company lost out on a big opportunity at least initially.

Dr. Reddy’s has a host of big potential products like Olanzapine, Ondansetron, Clopidogrel and Terbinafine HCl in its US generics Para IV filings pipeline, which could generate considerable revenues for the company going forward. An indication of a probable launch of these products is given in the table alongside along with possible revenues in the first year of launch. These are products with tremendous potential but with higher risk and uncertainty. As can be seen from the table below, the company has a fairly good product line up for the next 5 years.

Dr. Reddy’s: Generics Coffer
Product Expected Launch
Year
Therapeutic segment Est. Sales in year
of launch (US$ m)
Omeprazole FY04 Anti-ulcerants 23
Ciprofloxacin HCL FY05 Anti-infective 3
Olanzapine FY05 Anti-depressant 15
Ondansetron FY05 Anti-emetic 64
Clopidogrel Bisulfate FY06 Cardiovascular 50
Amlodipine Maleate FY06 Cardiovascular 75
Terbanifine HCL Tablets FY07 Anti-infective NA

On a conservative side, we have included revenues only with reasonable certainty. The company pursues such opportunities on a continuous basis and the list is likely to expand. At the current market price of Rs 833, the stock trades at a P/E of 20.5x its FY03E earnings. Without any revenue surprises, valuations look adequate and thus, the stock is likely to remain range bound for a while. However, the stock could witness a re-rating as and when certainty on any news flows on the success of Para IV filing surfaces.


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