Dr. Reddy's Laboratories: Hold/Avoid fresh exposures

Recommendation: Hold/Avoid fresh exporsures

Sanjiv Shankaran

Dr. Reddy's Laboratories' performance for April-December period of this year are not comparable with the corresponding previous period because the company has seen a significant merger in the intervening period.

The group company, Cheminor Drugs, that focussed on exports to regulated markets such as the US, has been merged with Dr. Reddy's. Therefore, the results for April-December are of the merged entity.

Dr. Reddy's sales for the first nine months was Rs 627 crore. With the addition of non-operating income of about Rs 23 crore, the total income was Rs 650 crore.

Following the merger of Cheminor Drugs, the role of bulk drugs, especially in exports, has grown in importance. Cheminor's bulk drugs exports to the developed markets appear to have raised the profile of bulk drugs in the company's sales mix. The sales mix for the third quarter (details available only for the third quarter) show that 51 per cent of the revenues came from bulk drugs. And within bulk drugs, exports comprised 69 per cent of the sales.

Dr. Reddy's formulations business comprised about 46 per cent of the sales mix. The company's portfolio has widened with the inclusion of Dai-ichi Karkaria's brands and new introductions.

Dr. Reddy's operating profits for the first nine months of this year was Rs 166 crore. The operating profit margin was 25.53 per cent. The net profit for the first nine months was Rs 95 crore and the net profit margin 14.61 per cent.

Dr. Reddy's annualised earnings per share (EPS) is Rs 40 (including the equity addition, post-merger). At the current price level of about Rs 1,300, the company's PEM is about 33.

Outlook:Compared to its valuation over the last couple of years, Dr. Reddy's appears attractively priced. But the situation has not been static with quite a few changes taking place in the operating environment of pharmaceutical companies, the most important being the slow progress made by Indian companies in the US generic market. Projected successes in the generics market played a significant role in valuation models and with success hard to come by, the element of risk while valuing a pharmaceutical company has increased.

Valuation of Indian companies' R&D potential has also been rather optimistic. A mere patent of a molecule does not translate into a successful commercial launch. Basic research entails a high degree of risk, a factor that may impinge forcefully on valuation models. For the moment, investors may avoid further exposures to Dr Reddy's.