USFDA’s Action On Dr Reddy’s Lab To Have No Major Impact

Indian pharma compnay, Dr Reddy’s Laboratory (DRL), would face an USFDA audit later this month. Generally when USFDA approval is granted, the stocks show some spike in the price and hence this event would be watched keenly by the markets.

In November 2010, USFDA had inspected the chemical manufacturing facility of Dr Reddy’s Laboratory in Mexico. Post the inspection, in June 2011 the company received a warning letter. Later in July 2011, USFDA issued an import ban on this facility for violation of the current good manufacturing practices (GMP). This ban has arisen as the company failed to take corrective actions against certain explanations sought by the USFDA.

This ban is of the nature ‘Detention Without Physical Examination’ (DWPE) which means that the plant will serve the ban until the USFDA is fully satisfied with the processes followed in the plant and proper documentation is provided to the regulator. .

The Mexican facility produces active pharmaceutical ingredients and comes under the business segment ‘Pharmaceuticals Services And Ingredients’ (PSAI). The PSAI segment contributed about 26 per cent to DRL’s topline in FY11. The contribution of the Mexican facility is USD 60 million (about 4 per cent) to the total revenues. Of the all products it makes from this facility, one product, Naproxen (annual sale of USD 30 million), is exempt from this ban. Going by these numbers, the products which are currently banned provide only 2 per cent in revenues which we believe is not a very big number.

That apart, the sales of the PSAI in the last three quarters also reflect an optimistic picture. In the quarter when the ban was imposed, the revenues from PSAI increased by 11 per cent while in the next quarter i.e. the September quarter the sale grew by 25 per cent on a YOY basis. The latest quarter saw flat numbers for the nine months ended December 2011 while the total PSAI sales are up by 12 per cent. Besides, in its other businesses and products we see significant high growth and hence there may be a negligible impact of the current ban even if the company fails the USFDA audit.

One more thing worth mentioning is that the gross margins of the PSAI segment in all these quarters have remained in the levels of 27-35 per cent compared to 22-28 per cent in the first three quarters of the last fiscal. To go by these numbers and the recent launches that the company has done in the US we maintain our call to buy the scrip. We have already carried an analysis of DRL in our latest issue (Dalal Street Investment Journal, Vol 27, Issue No 7) with a ‘buy’ call on it.