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Morningstar | Dr. Reddy’s Is Well-Positioned for Growth, but We Continue to View the Firm Without a Moat

Dr. Reddy's ongoing penetration of the U.S. generics market and and emerging-market exposure add up to attractive growth prospects. The company has an established brand in many emerging markets where rising disposable income, a fragmented customer base, and lower generic drug utilization rates offer attractive growth opportunities. Since many global drug markets lack a consolidated and efficient drug distribution infrastructure, generic drug manufacturers generally sell most of their product--frequently called branded generics--to independent pharmacies and physicians in these areas. Brand recognition generally supports customer loyalty and more stable prices, but governments can intervene with mandated pricing or tender-based bidding. Despite ongoing pricing pressure in the U.S. generics market, market share gains in the large U.S. and European regions offer attractive growth opportunities for Dr. Reddy. The company has racked up numerous successful drug launches, but its manufacturing scale, research capabilities, distribution networks, and legal acumen still lag larger competitors, in our view. While we do expect that its low-cost operating structure will sustain market share gains, Dr. Reddy's shift into the more-commodified developed markets may eventually erode the firm’s returns on capital.Management hopes to develop more complex manufacturing capabilities in market segments where limited competition supports stronger pricing power and higher profitability. Dr. Reddy has made relatively strong inroads into generic over-the-counter products and has also launched four biosimilars--near-generic equivalents of biotech drugs--in India and other emerging markets. However, we think U.S. and European approval for Dr. Reddy's biosimilars remains improbable in the near future, owing to the more stringent approval criteria in these regions and recent regulatory woes. In 2012, management initiated a partnership with Merck KGaA--now part of Fresenius Kabi--to bolster its biosimilars program.