Dr. Reddy’s, headquartered in Hyderabad, India, is a global pharmaceutical company offering a portfolio of products and services including APIs, generics, branded generics, biosimilars, and OTC. The company targets major therapeutic areas such as gastrointestinal, diabetology, cardiovascular, oncology, pain management, and dermatology. Geographically, Dr. Reddy’s caters to North America, Europe, India, and other Emerging Markets. In terms of revenue mix, Global Generics contributed 87.9% of FY24 (ended March 2024) sales, followed by Pharmaceutical Services and Active Ingredients (PSAI) at 10.7%, and Others at 1.4%.
Unlocking future potential with R&D spend
The global pharmaceutical industry has witnessed substantial change in the business landscape in the post-pandemic phase. Companies, to remain competitive, have refreshed their portfolio strategies and prioritized investments in research and development (R&D) activities, including the development of novel therapies, as well as enhancing digital capabilities. As per a recent report by IQVIA, the total worldwide pharmaceutical R&D spend in 2023 stood at an impressive USD262bn (7.4% YoY growth), following a 2.2% YoY decline in the previous year (2022) owing to a higher base effect from the peak COVID-19 impacted year (2021). Global R&D spend is further projected to grow to USD302bn by 2028, demonstrating a compound annual growth rate (CAGR) of 3.6% over the 2022-28 period. In-line with sector Dr. Reddy’s R&D increased at 8% CAGR over FY19-FY24, with FY24 R&D clocking a growth of 18% YoY (highest annual increase in last 5 years). Additionally, the company reported an R&D spend of INR7.3bn in 2QFY25, a robust 33% YoY increase, as the company is developing a strong pipeline of small molecules, biosimilars and novel oncology assets, through internal and collaborative efforts, to drive future growth.
Improved volume and new product launches
Dr. Reddy’s registered a steady increase in revenues over the last five years, delivering a CAGR of over 12% to INR279bn. The company’s bottom-line registered even better performance, demonstrated by a CAGR of 24.3% to INR55.7bn over the same period. Consequently, EPS surged from INR22.7 in FY19 to INR66.9 in FY24. Additionally, the debt levels have reduced considerably from INR38.4bn in FY19-end to INR20.0bn in FY24-end, signaling a marked improvement in the leverage ratios over the years.
The company’s peers Cipla Limited (NSE:CIPLA, BOM:500087) and Zydus Lifesciences Limited (NSE:ZYDUSLIFE, BOM:532321) also demonstrated revenue and net income growth over the last five years, albeit at a lower rate. Zydus’ revenues and net income grew at a CAGR of 8.1% and 15.9% to INR195bn and INR38.6bn, respectively, whereas Cipla registered a CAGR of 9.4% and 22% to reflect sales at INR255bn and net income at INR41.2bn, respectively, in FY24. On the margin front, Dr. Reddy’s demonstrated a larger expansion in gross margins compared to its peers over the last five years. The gross margin increased by 438 bps to reach 58.6% in FY24, compared to an increase of 418 bps for Zydus to 67.3%, and 90bps increase for Cipla to 64.6%.
Dr. Reddy’s has consistently surpassed sales expectations in the last seven quarters, reflecting the strong top-line performance. Continuing with its growth momentum across businesses, Dr. Reddy’s delivered decent top-line performance in 2QFY25. Revenues increased 17% year-on-year (YoY) to INR80.2bn, aided by 17% YoY growth in Global Generics revenue to INR71.6bn. Improved sales volumes and new product launches sustained the momentum in the Global Generics business. Geographically, within the Global Generics segment, North America sales grew 17% YoY to register sales of INR37.3bn, driven by an increase in sales volume and partly offset by price erosion. The company launched four new products during the quarter, which aligns with its plan of launching 15-20 products in the region in FY25. Global Generics sales from Emerging Markets reportedly grew 20% YoY to INR14.6bn, primarily supported by higher volumes in the base business. Within the segment, Russia business demonstrated increased traction, clocking 27% YoY growth. India sales witnessed an impressive 18% YoY growth to INR14bn, driven by additional revenues from the vaccine portfolio recently in-licensed from Sanofi, launch of new products and hike in prices.
Reasonable valuation levels
Dr. Reddy’s valuation levels appear to be reasonable compared to its peers, Cipla Limited and Zydus Lifesciences Limited. The company is currently trading at a P/E ratio of 18.0x (based on estimated FY25 EPS of INR69.7), compared to a P/E of 25x for Cipla and 22x for Zydus. The company is also trading at lower levels compared to the historical 10-year average P/E of 28x. Additionally, valuation through the EV/EBITDA approach also reflects a lower valuation for the company at 11x, compared to 16x for Cipla and 14x for Zydus. On a historical basis, Dr. Reddy’s is trading lower compared to the 10-year EV/EBITDA average of 14x. Dr. Reddy’s stock has delivered modest returns of over 8% in the past one year and over 7.5% in the YTD period. Most of the 39 analysts covering the stock have a “Hold” rating with an average target price of INR1,336.0, indicating an upside potential of 5%.
Overall, the company should be on the radar of investors owing to its positive top-line trajectory, increase in sales volume, and new product launches in key markets. The fundamentals should be further supported by the acquisition and integration of Nicotinell with the company. However, operations in the pharmaceutical sector also present inherent industry risks including long-gestation periods, foreign exchange, failure to obtain approval from regulatory bodies, or regulatory observations which can make the sales very volatile and uncertain. Nevertheless, the sector also presents ample opportunities to the key players, marked by growth potential in generics and biosimilars owing to LOE across the top ten developed markets.
