Analyst Call Tracker | Brokerages fall out of love with Dr Reddy's, caution spreads over recent acquisition

Dr Reddy's has run-up 12 percent in the past month, which according to analysts, leaves little room for a further upside.

Analysts have turned cautious on drugmaker Dr Reddy's Laboratories, with a majority of brokerages covering the stock either giving it a 'hold' or 'sell' call. Reasons pointing towards the cautious stance include concerns over earnings moderation in the medium-term, lack of rationale behind its recent acquisition of Haleon’s nicotine replacement therapy (NRT) brands and expensive stock valuations.

As per Moneycontrol's Analyst Call Tracker, out of the total 40 brokerages covering Dr Reddy's, 14 gave a 'sell' call while 12 assigned it a 'hold' rating. It was only the remaining 12 that issued it a 'buy' call, taking the scrip in the list of Nifty 50 stocks garnering the most pessimism from the Street.

Despite pessimism from analysts, investors continued to lap up shares of Dr Reddy's in the past month, lifting the stock nearly 7 percent higher during the tenure. With this, the stock also ranked high in the list of contrarian downgrades which collates stocks that have risen despite negative ratings action.

Why the acquisition?

The Street had been eagerly waiting for acquisition from Dr Reddy's for quite some time now, especially after the company divested a few brands in the domestic market and was falling short on a strong US pipeline. However, its decision to acquire Haleon’s NRT portfolio was a step that left the Street bewildered.

Analysts are sceptical about the significant investment in consumer OTC brands by Dr. Reddy’s. They suggest the company should focus on its core pharma business, such as global specialty drugs or Indian generics, where it appears to be lagging behind industry rivals like Sun Pharma.

The acquired business has shown subdued growth, with revenues increasing by less than 4 percent annually on average between 2021 and 2023. To boost growth, Dr Reddy’s will need to ramp up investments in advertising, sales promotion, and new product launches, analysts noted.

Jefferies said that the OTC brands being acquired would require upfront investments. "Further, the impact of synergies from the acquired portfolio should start reflecting only over FY27-28," the brokerage added.

Nomura analysts believe a focused approach on select countries like the US and India would be more effective for building the consumer business.

Nuvama Institutional Equities also stated that while the foray into OTC is low-risk and earnings-accretive with reasonable valuations (~2x sales/11x PE), the category has seen lacklustre growth with little innovation, and the payback period is long (9-10 years) with no immediate scale.

Nomura has a 'neutral' recommendation on Dr Reddy's while Jefferies has an 'underperform' rating and Nuvama maintained a 'reduce' rating.

Earnings to moderate

The lack of upside triggers for the company beyond its blockbuster cancer drug Revlimid is another major concern for brokerages. Like the previous few quarters, it was the strong contribution from Revlimid that nursed the January-March earnings of Dr Reddy's. Brokerage firm Nomura attributed Revlimid's contribution to supporting the drugmaker's strong gross margin and operational performance in Q4.

However, going ahead, analysts expect the company's earnings to moderate as contributions from Revlimid wear out and research and development (R&D) costs rise.

Nuvama also anticipates that Dr Reddy's to face higher R&D costs (as a percentage of sales) over the next few years due to its Horizon 2 program, which includes biosimilars and complex products.

Jefferies adds that, in addition to the higher R&D costs, Dr Reddy's EBITDA margin for FY25 is likely to be under pressure from a weak US launch pipeline.

Factoring these in, Motilal Oswal Financial Services projects earnings growth for Dr Reddy's to moderate to a 3.5 percent CAGR over FY24-26, partly due to the gradual market share build-up of the Revlimid generic.

On top of these concerns, the stock's sharp 12 percent run-up in the past month leaves little room for a further upside, analysts believe.

Also Read | Jefferies issues 'underperform' call on Dr Reddy's, Nomura not convinced on rationale of acquisition

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