Dr. Reddy’s: Benefiting from an R & D led re–rating

Dr. Reddy’s Laboratories (DRL) has shot up almost 24% in the last one month. The company has been one of the pro–active companies among Indian pharmaceutical companies in preparing for the product patent regime. As per the C–Marc Prescription Audit Data, the company is among the top 5 domestic formulation companies with a 1.9% share of all drugs prescribed by doctors.

The company’s product profile is focused on anti–ulcer, anti–pain and anti–infectives segment. For its R & D efforts it has focused on the anti–diabetes segment so far (more on that later). It is this focus on its core competence that has enabled DRL to report a 34% growth in finished dosages in FY2000 when the overall formulation market grew by 9.2%. These were led by a 25% growth in Omez (the company's anti–ulcer drug), a 28% growth in Nise (anti–pain) and a 49% growth in Ciprolet (anti–infectives). The company’s top six brands Omez, Nise, Ciprolet, Stamlo, Enam and Stamlo Beta contributed 57% to the total turnover of the company. Ciprolet's success is particularly noteworthy since the anti–infectives market has grown by hardly 4%.

Also, the Russian problem has become less relevant with Russia’s diminishing importance due to the company’s aggressive expansion in markets such as China and Brazil. Infact the company’s exports grew by 39% to non–Russian markets (albeit over a smaller base of Rs 180 m).

As far as R & D is concerned in a sense, it was DRL, which pioneered pharmaceutical Research & Development among Indian pharmaceutical companies when it licensed its anti–diabetes insulin sensitiser DRF 2593 to a Danish company Novo Nordisk. The company arguably has the best R & D pipeline in the country with almost five molecules in pre–clinical trials.

What seems to be driving the stock however, is the consolidation of group interests. The acquisition of American Remedies and the amalgamation with Cheminor Drugs would catapult DRL to being the third largest pharmaceutical player in India. We expect the company to report a net profit in the range of Rs 1100 m in the current year. This implies an EPS of over Rs 34 on the consolidated equity and an earning multiple of over 40 times FY2001 earnings.

While there seems to be no dramatic undervaluation at current levels, the company has definitely benefited from an R & D led re–rating.