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Morningstar | Dr. Reddy's Fiscal 3Q Results Track Expectations; U.S. Price Erosion Persists

Dr. Reddy's fiscal third-quarter results largely tracked our expectations. While the company's North American generics revenue is showing early signs of stabilization, we don't anticipate any major changes to our fair value estimate, and we are reiterating our no-moat rating.

The company's global generic revenue was mixed across regions during the quarter. The segment's overall revenue grew by roughly 4% thanks to emerging-market performance, and we think brand recognition of Dr. Reddy's in emerging markets will continue to bode well. The company held 43% generic drug revenue growth in its rest of world category, thanks to new product launches. Meanwhile, the relatively weak North American generic performance (regional revenue was down by 8% versus the year-ago period, but grew 1% sequentially) was mostly due to higher price erosion across several key products. Furthermore, the company's overall gross margin fell by 240 basis points compared with the year-ago period, primarily due to price erosion in the U.S. We still anticipate pricing pressure to remain as a regional headwind, and we think the company's efforts to optimize its cost structure will remain a key focus.

Dr. Reddy's regulatory updates show it's still struggling to fix concerns raised by regulators. The company received eight observations after its Duvvada oncology site reinspection in October 2018. Encouragingly, a formulations plant in Srikakulam was completed with zero observations in November 2018. More recently, however, several issues have persisted. During January 2019, the company received four more adverse observations during the inspection of a separate Srikakulam formulations plant, along with one additional observation from the inspection of its API plant at Miryalaguda. We continue to think remediation of these facilities is severely overdue, and margin pressure could persist longer than we expect if manufacturing issues consistently arise.