Indiabulls has recommended a `Hold` on Dr Reddy's Laboratories

The stock is currently trading at a forward PE of 15.3x and 12.6x for FY10 and FY11 earnings estimates. Indiabulls`s DCF-based valuation assumes a 12.3% WACC and a 5.0% terminal growth rate, suggests a target price of Rs 961. DRL has seen a sharp rise of 25% in its stock price over the past 15 trading sessions.

Dr Reddy's Laboratories (DRL)`s top line increased by 21.5% yoy in Q1`10 to Rs 18.2 billion, backed by 27% growth in global generics and 6% in PSAI business (ex-Sumatriptan, revenue grew 7% yoy). EBITDA more than doubled reflecting the benefit of high-margin sales from Sumatriptan as well as certain cost synergies. The better-than-average generic pricing also resulted in a strong 12.6 pts yoy gain in EBITDA margin, excluding the one-offs relating to Betapharm and Atlanta research.

Though, DRL`s performance in the German market is likely to be subdued, Indiabulls are confident about growth in the company`s overall revenues and profits on the back of solid performance in the US and India. However, the company`s stock price has vaulted on rumours of a possible promoter stake sale of 5% to GlaxoSmithKline (GSK), one of the world`s top pharma players. This has left a tad room from current levels and hence, we downgrade our rating to Hold with a target price of Rs. 961.

Momentum in the US core business, which grew 58% yoy in FY09 (excluding Imitrex exclusivity) continued in Q1`10 with 42% growth. An additional upside is likely to come from a positive FDA decision on generic `Fondaparinux` and better market share in generic Omeprazole Mg OTC which has recently fetched USFDA`s approval.  The recent move of DRL of signing up with GSK to develop and market select products across emerging markets outside India could be significant value generators. Growth in domestic market is likely to revive materially in H2`10. Moreover, in the long term, the biologic capabilities should also add significant value.

Earliest indications from the German market after the onset of AOK (health insurance major) tender system suggest that the impact on top line and margins could be even worse than expected. DRL`s revenues from the German market dropped 38% yoy in Q1'10, despite ~5% depreciation of rupee against euro. Though, the company does not disclose margins separately for Betapharm, however, it is taking more radical steps on the cost side to hold on to margins.

Last fortnight, the company`s stock price has vaulted on rumours of a possible promoter stake sale of 5% to GSK thus leaving a little room for upsides from current levels. However, we continue to believe that the quality and visibility of earnings, technological capabilities, management quality, and good disclosure norms make DRL, the best long-term keep in the pharma space.