Dr Reddy's Labs: The bull vs bear case

Shares of Dr Reddy's Labs have been on a downward journey over the past two months, amid concerns over a warning letter the company received from the US FDA over some of its plants, and amid some currency headwinds it faces.However, following a nearly 30 percent decline, some analysts believe there may be further downside in the counter, while others believe the bad news may now have been baked into the price and that things may look up from hereon.CNBC-TV18 caught up with Sarabjit Kour-Nangra, VP-Research, Angel Broking and independent market expert Ambarees Baliga, who presented the bull and bear case, respectively, on the stock.Sarabjit Kour-NangraOur argument stands primarily because of valuations. If you look at Dr Reddy in terms of events have panned out, obviously they have a bad news out there in terms of their three plants going through a tough time with USFDA, and there is a risk that these three plants could go for an import alert. The key contention is that two plants are API plants and the third one is biological. The biological doesn’t contribute significantly while for two API plants, site transfers are happening, API is a source of formulation so they can do site transfers and source from third party. It definitely takes time for such things or events to pan out and definitely few quarters will be impacted. Secondly, the thing about the Venezuela currency, definitely it will have a quarterly impact because of the volatility but Venezuela as per se contributes hardly 3-4 percent on the topline. So, again, not a very significant blow out in terms of overall scheme of things. Valuations-wise, the stock is trading at 17 times FY17 earnings growth. Even after the impact, which we expect to the extent of topline around 12-15 percent, stock has already corrected more than 30 percent. So, I rest my case there that the fall in the stock is more than the earnings downgrade that should have been happened.We are looking at somewhere around 14-15 percent topline growth.So, I guess to that extent the stock is already factoring in so obviously from a fundamental perspective these are the times when you pickup stocks -- the way it happened in Sun Pharmaceutical recently. Those are the times to get into pharmaceutical companies when they trade below their fair valuations because pharmaceutical companies you will never normally get at fair valuations because they are a defensive and steady earnings company. So, when such events happen, these are the times to get into these stocks. Ambareesh BaligaFor the last two-three years, I have been bullish on Dr Reddy's and generally I am a contrarian buyer so it would be expected that when the stock has fallen so much I could be a buyer at these levels. Normally, for pharmaceutical companies especially the largecap ones, whenever there is a USFDA warning, I say possibly that is a good time to start buying. However, this time it is different for Dr Reddys. The first reason is disclosure levels. I think those two facilities was not there on the radar at all and people were in fact looking at Srikakulam facility. So, this came as a surprise. The biggest issue out here is corporate governance. Number two, I think this issue will take slightly longer than expected. I think it could take two years plus to get resolved. There is a possibility of an import alert. US sales again could be flat going ahead. On Venezuela, again impact could be felt and because of that we are looking at an EPS of about Rs 130-135 for FY17. I think more than the EPS impact, I think it is the valuation impact which will be felt on this company. So, I am not saying that it is going to crack too much further from here; it has already cracked decently well, it can go to levels of about Rs 2,400-2,500 because of the valuation correction. Even if it doesn't fall, it could stay at current levels.When one is investing one should be looking at what better opportunities are there in the same space. So, I think the larger investor, the more serious investors, nearly 42 percent is held by FIIs and institutions. 42 percent again is held in Lupin, 36 percent is held in Sun Pharmaceutical so I think people will shift from possibly Dr Reddys to Lupin and Sun Pharmaceutical and that itself can create some more pressure.