Dr Reddy’s stock has underperformed the sector so far this year. The stock is down around 21% vs 10% fall in Nifty pharma. With the further deterioration of Russina’s macroeconomic outlook, investor concerns are likely to remain high in the near term. This could lead to continued underperformance of the stock in the near term.
Dr Reddy’s share price has corrected around 23 per cent so far this year. The stock has been under pressure amid ongoing Russia-Ukraine conflict as among the India Pharma companies, Dr Reddy’s is most exposed to Russia and Ukraine. Despite the steep correction in 2022, Brokerage firm Nomura remains bullish on the stock. The positive view is driven by strength in other businesses, Nomura said. It has maintained its ‘buy’ rating on the drug maker’s stock, and is constructive on the stock as the current weakness presents an opportunity to accumulate Dr Reddy’s shares.
Dr Reddy’s exposure to Russia, Ukraine
Russia is highly dependent on imports for pharmaceuticals. Among the India Pharma companies, Dr Reddy’s is most exposed to Russia and Ukraine. The pharmaceutical formulation exports to Russia from India is at Rs 3800 crore(CY21). Dr Reddy’s Russia sales on average account for nearly 50% of overall exports to Russia. Meanwhile, the India pharmaceutical exports to Ukraine is at Rs 1100 crore for CY21 and Dr Reddy’s sales in Ukraine was around 30% of exports from India. Dr Reddy’s sales to Russia accounted for 8-9% of consolidated revenues in the recent past. Revenues from Ukraine are at 2% of sales.
Depreciating Ruble: The ongoing geopolitical tensions have led to multiple economic and trade sanctions against Russia. This includes the inability of Russia’s central bank to access its reserves. This has led to substantial depreciation of Russian currency over the past two weeks. Against the Indian Rupee, Russian Ruble (RUB) has depreciated around 35% since 16 February 2022.
Impact of depreciating Ruble
“Based on the subsidiary financials and interaction with the company, we estimate the overhead costs in RUB terms is ~30% of sales. Hence, the net RUB exposure is ~70% of sales. The impact on EBITDA and earnings just on account of RUB depreciation (from Rs 0.95 to Rs 0.65) vs INR is estimated at 7-8% and 9-10%, respectively, for FY23-24 estimates. In the recent past, the company increased its cash flow hedges against RUB, which may help negate some impact over the next 12 months. The outstanding hedge as of December 2021 is at RUB 5,875 mn which is 33% of trailing 12-month sales.
Depreciation of Russian currency is likely to lead to higher prices for pharma imports. “In the past, the yearly price increase in pharmaceuticals has been around 10%. During the previous period of currency depreciation in FY15-16, the price increase was somewhat higher at 13-14%. The contribution from OTC products for Dr Reddy’s has increased over the years to ~47% in 9mFY22. Typically, in Russia, the price increases in OTC products are higher than for prescription products. Nonetheless, the contribution from higher prices is likely to only marginally negate the impact of the very sharp currency depreciation, in our view,” said Nomura.
The brokerage further added that there is likely to be an additional impact of lower volume demand due to weakness in the economy. As such, the volume growth in the Russia market was weak in the past, which may become further impacted. Receivable days in Russia is high at 200 and company would like to voluntarily lower volumes to reduce debtor risk in the market.
Profitability of operations in Russia to be significantly affected
Since Russia is a strategically important market for Dr Reddy’s, sharp depreciation in currency will significantly affect the profitability of operations in Russia. “At the current INR/RUB currency rate, we think the EBITDA margin of the Russian operations might have contracted to single digits or to low double digits at best. If the macros and fundamentals of the market remain weak, it is likely DRRD may de-prioritise the market over time,” Nomura said.
Dr Reddy’s stock rating: BUY
Target price: Rs 5,552
Dr Reddy’s stock has underperformed the sector so far this year. The stock is down around 21% vs 10% fall in Nifty pharma. “With the further deterioration of Russina’s macroeconomic outlook, investor concerns are likely to remain high in the near term. This could lead to continued underperformance of the stock in the near term,” Nomura said. From a 12-month perspective, the brokerage remains constructive.
Dr Reddy’s successfully cleared the Duvvada injectable plant inspection by the US FDA. Company’s management expects injectables to be an important contributor to growth in the US market in the near term and clearance of the site improves visibility. The overall earnings are also supported by the depreciation of Indian Rupee against the US Dollar and other exporting currencies. In addition, over the next 2-3 years there could be potential upsides (vs current expectations) from acquisitions and partnerships, PSAI and China. The brokerage has a ‘Buy’ rating on the target with a target price of Rs 5,552, implying nearly 50% upside.