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Despite regulatory and competitive challenges, Dr. Reddy looks better positioned for generics growth

Morningstar's Take | 05/01/2018
by Michael Waterhouse

Investment Thesis

Dr. Reddy's ongoing penetration of the U.S. generics market and and emerging-market exposure add up to attractive growth prospects. The company has an established brand in many emerging markets where rising disposable income, a fragmented customer base, and lower generic drug utilization rates offer attractive growth opportunities. Since many global drug markets lack a consolidated and efficient drug distribution infrastructure, generic drug manufacturers generally sell most of their product--frequently called branded generics--to independent pharmacies and physicians in these areas. Brand recognition generally supports customer loyalty and more stable prices, but governments can intervene with mandated pricing or tender-based bidding. Besides its own brand recognitions, Dr. Reddy has global distribution agreements with AstraZeneca and GlaxoSmithKline.

Despite ongoing pricing pressure in the U.S. generics market, market share gains in the large U.S. and European regions offer attractive growth opportunities for Dr. Reddy. The company has racked up a handful of successful drug launches, but its manufacturing scale, research capabilities, distribution networks, and legal acumen still lag larger competitors, in our view. While we do expect that its low-cost operating structure will sustain market share gains, Dr. Reddy's shift into the more-commodified developed markets may eventually erode the firm’s returns on capital.

Management hopes to develop more complex manufacturing capabilities in market segments where limited competition supports stronger pricing power and higher profitability. Dr. Reddy has made relatively strong inroads into generic over-the-counter products and has also launched four biosimilars--near-generic equivalents of biotech drugs--in India and other emerging markets. However, we think U.S. and European approval for Dr. Reddy's biosimilars remains improbable in the near future, owing to the more stringent approval criteria in these regions and recent regulatory woes. In 2012, management initiated a partnership with Merck KGaA--now part of Fresenius Kabi--to bolster its biosimilars program.


The company's drug-specific strategy places a higher degree of success on limited product launches. As such, product recalls represent modest setbacks since the company's product portfolio lacks the diversity of its larger competitors. Dr. Reddy's faced some limited product recalls in 2009 and 2014, as well as a year-long import ban on its Mexican manufacturing facility in 2011. More recently, in 2015 the company was slapped with a U.S. Food and Drug Administration warning letter regarding three of its India-based facilities. While the company appears to be working torward an appropriate resolution to these manufacturing issues, regulatory uncertainty over production quality remains a risk.

The company's foray into Europe has been more painful. The company extended its reach into Europe through the 2006 acquisition of Betapharm, a German generic manufacturer, for about $570 million. Soon thereafter, Betapharm's revenue crumbled as the German market shifted to a partial tender-based market system. Betapharm's losses have forced Dr. Reddy to take significant write-offs on its assets. As a result, we’d be skeptical of any future potential international acquisitions. Also, Dr. Reddy's brand recognition is likely to face stronger competition in the coming years as larger players with greater financial resources hope to expand and diversify operations in the faster-growing emerging markets.

Company Profile

With headquarters in India, Dr. Reddy's Laboratories develops and manufactures generic pharmaceuticals. The firm operates in three divisions: global generics, proprietary products, and active chemical ingredients. The global generics and pharmaceutical services and active ingredients segments make up most of the company's revenue at about 80% and 17%, respectively. About 85% of Dr. Reddy's sales are based outside of India, with approximately 48% from North America and 12% from Europe.

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Bulls Say

  • Dr. Reddy's ability to launch difficult-to-manufacture drugs with limited competition, such as Arixtra and Allegra, builds the company's presence in developed markets without sacrificing profitability.

  • In the U.S. and Russia, Dr. Reddy has grown quickly in over-the-counter generics, which is an attractive segment of the market with slightly higher barriers to entry than conventional retail pharmacy drugs.

  • Dr. Reddy's strong brand presence in emerging markets provides significant growth opportunities with less price competition than typically seen in developed markets.

Bears Say

  • Dr. Reddy should face greater competition in its emerging-market strongholds, such as Russia and India, as numerous competitors look to expand.

  • Although it markets biosimilars in emerging markets, Dr. Reddy will likely remain reliant on partnerships for these products in the U.S. and European markets because of higher regulatory, manufacturing, and intellectual property barriers.

  • Though Dr. Reddy has surpassed other Indian generic manufacturers in entering the U.S. drug market, it still lacks the prowess of its larger global competitors and faces the scrutiny of the FDA.

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