Dr Reddy's Laboratories – Headwinds now spread to the US:: RBS

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DRL is now facing headwinds in monetising its robust US pipeline (gArixtra and gAllegra D-
24 OTC) in addition to our existing concerns about weak business mix (PSAI and
Betapharm). Also, the recent US FDA warning letter on DRL's API unit in Mexico could
further delay recovery at the PSAI business, in our view. Sell.


Fondaparinox (generic Arixtra) remains in the waiting room
US FDA approval of fondaparinox – generic (g) Arixtra – has been delayed by yet another
quarter. Dr Reddy’s (DRL) and its technology partner, Alchemia, are developing this difficultto-
make product together, and will share the profits, but have been awaiting its approval
since January 2011. We had previously pushed back our assumption for the launch of this
product from 4QFY11 to 1QFY12 and now expect approval in 2QFY12. Based on this
expected launch date, we estimate gArixtra will contribute Rs4.1ps to core EPS for FY12.
Business mix remains weak; US business also facing headwinds now
DRL’s Pharma Services and Active Ingredients (PSAI) and Betapharm businesses (together
34% of FY11 revenues) continue to face headwinds due to pricing pressure. The recent US
FDA warning letter regarding DRL’s active pharmaceutical ingredients (API) manufacturing
unit in Mexico could hit the recovery of its PSAI business, in our view. India (16% of FY11
revenues) and Russia/CIS (15%), DRL’s most stable markets, also saw yoy sales decline
slightly due to intensifying competition and healthcare reforms, respectively. The US
business (25%), which has been DRL’s key growth driver, is now also facing headwinds. Its
track record in monetising products has recently been unimpressive, in our view – delays in
approval of gArixtra, plus reduced upside potential from gAllegra D-24 (prescription switch to

OTC). We thus think 1QFY12 may be less strong than it might have been. So, while DRL has an
impressive US pipeline (gArixtra, gAllegra D-24, gZyprexa, gClarinex, gGeodon), we believe the
upside is largely priced in (Table 1).
Reiterate Sell on weak business mix and rich valuations
We largely maintain our core earnings estimates but increase our overall FY12-13F earnings by
6-8% to factor in the revised payoffs of the Para-IV pipeline (one-offs). We also tweak our SOTPbased
TP to Rs1,360 (from Rs1,355) based on a valuation of Rs1,309 for its core business
(FY12F PE of 21.4x) and Rs51 for its Para-IV pipeline. We reiterate our Sell rating on a weak
business mix, the US business headwinds and unattractive valuations.