Published on 16/03/2017 3:04:34 PM | Source: Motilal Oswal Securities Ltd
Neutral On Dr Reddy’s Labs Ltd For Target Rs.3,050.00 - Motilal Oswal
Duvvada formulations plant receives 13 observations in re-inspection
Risk of delay in Gleevec launch; regulatory concerns to weigh on stock price
* US FDA re-inspection of DRRD’s Duvvada-based oncology formulations plant got over yesterday. Post inspection, US FDA issued 13 483 observations.
* Though the observations are not out yet, the number of observations is optically high. Oncology injectable sales account for >15% of DRRD’s US sales.
* Though long-term fundamentals remain intact, the stock would be range-bound in the near term due to regulatory concerns.
Key oncology facility; eminent risk of delay of Gleevec launch:
DRRD generates >15% of its US sales from the oncology segment, but exposure to current US sales from Duvvada facility is 7-8%. A large part of supply comes from third-party sources including Cipla and Gland Pharma. Currently, 15-18 ANDAs (out of ~90 pending ANDAs) are pending from this facility, of which 4-5 are pending in FY18- 19. Gleevec is the key launch due from this facility. Given that partner site (Hetero) has also come under regulatory scanner, if the Duvvada facility does not come back on track, Gleevec approval may get pushed by 6-9 months.
Miryalaguda observations not so concerning; Srikakulam inspection to be key:
In November 2015, US FDA issued a warning letter to Miryalaguda and Srikakulambased API plants and Duvvada-based oncology formulations plant (US FDA Link). Sales contribution from these facilities to US market is 10-12% of total sales (~USD250m) including ~2% from Miryalaguda, and 9-10% from Srikakulam and Duvvada. US FDA inspection at Miryalaguda got over in February 2017, with three 483 observations (largely procedural in nature). Srikakulam (the largest facility among these three) inspection is due in the next couple of weeks and it is crucial that this plant comes back on track quickly. One of the key observations raised at the Srikakulam facility was that US FDA found existence of an uncontrolled ‘custom QC laboratory’. Presence of this lab was unknown to US FDA.
Key that third-party consultant cost does not occur again:
DRRD has invested ~USD40m as third-party consultant cost to take remediation action at these three plant up till now. Third-party consultant cost has come down significantly, as the remediation is over now. It is crucial that DRRD does not incur this kind of cost again to fix current observations.
Will fate of one plant impact others? Still not clear:
Notably, these three plants received warning letters simultaneously and US FDA suggested global corrective action. It is unclear whether all three plants would be back on track together or each plant would be looked at separately. If the plants need to come back at one go, then it is imperative that all the inspections go well.
US FDA remediation key; maintain Neutral:
Though long-term fundamentals remain intact, the stock would be range-bound in the near term due to regulatory concerns. We value DRRD at 21x 1HFY19E EPS (in line with sector average), given its robust balance sheet, expectation of US FDA resolution over the next six months and rich product pipeline. We maintain Neutral; our target price is INR3,050.
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