Dr. Reddy’s: Well-Positioned for Future Growth Through New Products, but We Don’t See a Moat

After taking a fresh look at Dr. Reddy’s RDY, we have lowered its fair value estimate to $48 from $60 per share due to our revised future outlook of the company. Our updated forecast lies on a mid-single-digit top-line growth and an annual margin compression in its core generics portfolio as well as our updated analysis, shifting the company’s moat to no-moat from narrow.

Fiscal 2023 saw a healthy gross margin improvement from a launch of its generic equivalent of Revlimid in the U.S. Dr. Reddy’s had a volume-limited launch in September 2022 with a 180-day exclusivity. We saw a robust margin jump with this (gross margin increased from 49.9% during first quarter of 2023 to 59.1% in second quarter) and it stayed around this level until the end of fourth quarter. Now that it lost the market exclusivity and other players enter the market, we expect a material volume and margin erosion going forward.

Over the long term, we believe Dr. Reddy’s is prone to pricing pressures from governmental actions and other players in the drug supply chain as well as volume pressures from increasing competition in once-profitable drugs. To combat these headwinds, Dr. Reddy’s has committed to increase its presence in complex injectables and biosimilars, two areas that are poised to drive higher margins for pharmaceutical manufacturers. Complex generics, especially injectables, are more challenging to manufacture compared with small-molecule oral tablets. Therefore, the competition in this market is usually less severe, leaving more opportunities for manufacturers like Dr. Reddy’s to earn healthy profits. Currently, a quarter of Reddy’s North American portfolio is composed of injectables, which is higher than some of its key competitors in the region. Furthermore, 40% of its pipeline of 175-plus products in the region is made up of injectables and sterile products. We expect a similar level of the company’s research and development spending to be attributed to this market.