US FDA-beaten Dr. Reddy's Laboratories: Buy or Sell?

The stock of Dr Reddy's Labs declined 8.2% on Thursday on the company receiving a stern warning letter from the US FDA concerning its three manufacturing facilities. In the recent past, several leading pharma companies have faced flak from the US drug regulator shaking investor confidence. DRL has corrected 28% in the past three weeks on back of FDA woes. With the second largest pharma company facing adverse regulatory action, ET analyses the situation the way it stands for the company's inves tors. Do they sell the stock or look now for buying it low?

NO IMMEDIATE SUCCOUR: Historically, stern FDA action has led to a setback on the bourses. Depending on the gravity of the action, stocks of Ipca Labs, Cadila Healthcare and Wockhardt have shown varying degrees of recovery after the initial correction, indicating that recovery could take months.

PROSPECTS FOR DRL: A negative FDA action or lawsuit does not per se make DRL a bad stock. The company has a strong pipeline of drugs to be launched in the US and invests significantly in R&D.Investors need to keep a close watch as warning letters have the potential to escalate into import bans. While majority of the analysts are bullish, the number of 'buy' calls have dipped 35% in three weeks. It is better to avoid DRL till there is a clear sign of FDA issue not escalating.

CHANGE NEEDED IN INVESTOR PERCEPTION: Investors need to change the way they have traditionally viewed pharma stocks ­ from evergreen business stories to ones that are globally evolving in a competitive and regulatory environment. They have to brace themselves for uncertainty and volatility in these stocks.

GOVERNANCE TO BE TESTED: As Indian pharma achieves scale through organic and inorganic expansion, they are likely to suffer hurdles like action from regulators, lawsuits and stiff competition. This is a transition phase as they work to match US standards while using Indian infrastructure, workforce and quality control. DRL will be tested on how it overcomes these impediments. It also means increase in legal and compliance costs.

SOME RISKS ARE CALCULATED: Sun Pharma acquired Ranbaxy knowing well the regulatory quagmires that it was stuck in. Dr Reddy's Labs launched the generic of the heart burn pill Nexium in purple colour, the same colour as the one sold by innovator AstraZeneca. These have been calculated risks, which may cost the companies in case they go awry. However, in a globalised pharma landscape, these are risks worth taking.