UBS : Dr. Reddy's Labs - Mexico facility receives import alert

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UBS Investment Research
First Read: Dr. Reddy's Labs
M exico facility receives import alert
􀂄 Event: Dr Reddy’s Mexico facility put under US import alert
Following, the Jun 3, 2011 warning letter, US FDA placed Dr Reddy’s Mexico
API facility under import alert (according to Economic Times). According to the
co., the API facility has revenues of US$65mn in FY11 almost equally split across
US and EU. Naproxen is one of the key products manufactured at the facility
accounting for ~40% of the revenues.
􀂄 Impact: A likely hit of 2%-3% to FY12 earnings
According to the co., Naproxen is not covered by the Import alert. This is a low
margin facility; we believe gross margins are likely between 25%-30% at best.
Also, we currently assume that EU shipments are unlikely to be impacted.
Therefore excl. EU and assuming 50% of shipment of Naproxen are to the US, we
believe the revenue impact is likely to be only US$20mn and estimate the earnings
impact at about US$8mn (Rs 2.2/share or 2.5% of FY12 EPS estimate).
􀂄 Action: Maintain Buy, as ramifications are limited
While the event is unfortunate, we believe the impact on earnings outlook because
of the same is limited. There are no other facilities of the co. currently under
review by the FDA. We maintain our Buy on the stock given strong near term
earnings growth outlook and reasonable valuations.
􀂄 Valuation: Maintain Buy, PT Rs 1,900
We derive our PT from a DCF-based methodology and explicitly forecast long
term valuation drivers using UBS’s VCAM tool. We assume a WACC of 11%


􀁑 Dr. Reddy's Labs
Founded as a bulk drug firm in the 1980s, Dr Reddy's Labs (DRL) is now an
integrated company with a presence in the domestic and global formulation
segments with FY10 revenue of Rs69.9bn. Pharmaceutical services & active
ingredients made up 30% of sales in FY10 and formulations 70%. DRL derives
14% of sales from formulations sold in India, 14% from Europe and 25% from
the US, and 17% from finished dosages sold in the RoW. The remaining 30%
comes from pharmaceutical services & active ingredients. R&D is focused on
metabolic disorders, cardiovascular indications, anti-infectives and antiinflammation.
􀁑 Statement of Risk
We believe risks include regulatory risks, FDA approval, timing of approvals,
litigation (including the appeal process), accounting/disclosure, and product
pricing risk from generics competition. Pricing pressure in the US market
because of increased competition may continue. Margin pressure on account of
appreciation of the rupee could also negatively impact earnings. Dr Reddys also
has high exposure to the API segment where margins are more volatile than the
formulations segment.