Sun Pharma vs Dr Reddy’s: Which is Better?

Though less known, India is also famous for its high quality and cheap medicines.

As per data from the department of pharmaceuticals, India’s cost of manufacturing pharma products is 33% lower than western nations.

High quality medicines, at a cheaper rate, makes Indian medicines a popular choice across the globe. Such is the popularity of Indian medicines that India is known as the ‘pharmacy of the world.’

But how did India become the pharmacy of the world? Well, India’s pharma exports played a huge role in helping the country achieve this remarkable feat.

Although India exports all types of pharma products from medicines, vaccines to active pharmaceutical ingredients (APIs), generic medicines constitute a large part of pharma exports.

India is the world’s largest supplier of generic medicines. It accounts for 20% of the global supply of generic medicines by volume.

Of the total revenue the industry earns by selling various pharma products, generic medicines constitute 71%.

But what are generic medicines?

When a novel drug is developed, it’s issued a chemical patent. The novel drug is also called an ‘original’ drug. The company behind its development is known as an ‘innovator’ company. The patent provides exclusive rights to the innovator company to produce and distribute the drug. A chemical patent is valid for a period of anywhere between 15-20 years and cannot be renewed.

Once the patent expires, other companies are permitted to register their own version of the drug. These contain the same ingredients as the original drug.

Although a generic drug contains ingredients similar to the original, it may differ in terms of manufacturing process, color, packaging, etc.

Today, the Indian pharma industry is valued at US$41 bn. It’s expected to reach US$65 bn by 2024, growing at an estimated CAGR of 16.6%.

The growth in the industry would partly be driven by the growth in exports of generic medicines as several drugs are set to come off patent.

India’s largest generic exporting companies, Dr Reddy’s and Sun Pharma are going to be the biggest beneficiaries of increased spending on generic medicines going forward.

Business overview

Dr Reddy’s is an Indian multinational pharma company located in Hyderabad, Telangana.

It’s engaged in the business of manufacturing and supplying pharma products. The company also offers development and manufacturing services to other pharma companies.

The company boasts of a strong product portfolio which includes generic medicines, biosimilars, and APIs. Manufacturing services are provided through its wholly owned subsidiary Aurigene pharmaceutical services.

The overall business of the company can be broadly classified into three business segments. These segments are as follows:

1. Global Generics

2. Pharmaceutical services and APIs (PSAI)

3. Proprietary products & others

The global generic segment is the biggest business for Dr Reddy’s. It constitutes 81.4% of the total revenue of the company.

The generic portfolio of the company comprises more than 550 high quality generic medicines and 6 biosimilars spanning key therapeutic areas like oncology to gastro-intestinal, and more.

Sun Pharma is the leading pharmaceutical company in India.

The business can be broadly classified into three segments: Generics, APIs, and consumer healthcare.

The company is a leading manufacturer and supplier of specialty generics. Specialty generics are drugs which are effective in treating chronic and critical stage diseases like cancer.

Apart from generics, the company boasts of a strong portfolio of more than 300 APIs. Also, it owns consumer healthcare brands like Volini and Revital.

Dr Reddy’s races ahead in revenue growth

The following table shows the revenues of Dr Reddy’s and Sun Pharma over the last five years.

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Dr Reddy’s revenue grew at a CAGR of 6.1% over the last five years. This compared to Sun Pharma’s meagre five-year CAGR of 1.5%.

Companies like Dr Reddy’s and Sun Pharma, experience a phenomenon called ‘price erosion’ in generic medicines. As the competition increases, the price of medicines comes down drastically. This significantly affects their toplines.

Both companies were able to register growth on the back of higher volumes, new product launches and favourable forex.

Dr Reddy’s is planning to offset the effect of price erosion by offering contractual development and manufacturing services to other pharma companies. Sun Pharma is focusing on specialty products, a sophisticated area with less competition and higher margins.

Contractual development and manufacturing (CDM) service of Dr Reddy’s is a key differentiator for the company.

It helped the company to grow much faster than Sun Pharma. In financial year 2021, pharmaceutical services and APIs (PSAI) segment of Dr Reddy’s grew 24% over the previous year. It registered the highest growth among its business segments.

Dr Reddy’s is relatively more efficient than Sun Pharma as far as sales are concerned.

Muted growth but decent margins

The following table shows net profit clocked by Dr Reddy’s and Sun Pharma over a period of five years.

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Over a period of five years (2017-2021), Dr Reddy’s profits grew positively while Sun Pharma’s saw negative growth.

Dr Reddy’s net profit grew at a CAGR of 8.7% in the last five years whereas Sun Pharma’s profit declined and registered a negative CAGR.

As far as profit margins are concerned, Sun Pharma clocks a higher average of 13.1% compared to Dr Reddy’s average of 9.8%. Highly automated manufacturing and a tech laden supply chain ensured decent margins for both the companies.

Sun Pharma’s margins could expand in the coming years as it focuses on developing specialty generics in key therapeutic areas like oncology and immunology.

These are complex products manufactured by only a handful of big pharma companies. This means less competition and minimal price erosion.

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Dividends

The following table shows details of dividends paid by Dr Reddy’s and Sun Pharma.

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A company shares its accrued profits among shareholders if it has no plans of investing that money back in the business. The profit is shared in the form of dividends.

Dr Reddy’s has paid an average dividend of ₹22 per share over the last five years. This compared to Sun Pharma’s average dividend of ₹4 per share during the same period.

Another dividend related metric which investors generally look at before investing in any stock is the dividend payout ratio.

The dividend payout ratio is a ratio of the amount of dividend paid to shareholders with respect to the net income earned by the company, expressed as a percentage.

The five-year average dividend payout ratio for Dr Reddy’s and Sun Pharma is 24.6% and 30.3% respectively.

Return on Capital Employed (ROCE)

Return on Capital Employed (ROCE) is a measure of a company’s efficiency to generate return on the capital employed in the business.

The higher the ROCE, the better for investors. This is because they can expect regular dividend payments from the company or in the case of capex by the company, an appreciation in the stock price.

The following table compares ROCE of Dr Reddy’s and Sun Pharma.

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Five-year average ROCE of Dr Reddy’s and Sun Pharma is 13.1% and 12.5%, respectively.

Dr Reddy’s generates marginally better returns than Sun Pharma.

Valuations

Price to earnings (P/E) and price to book value (P/BV) ratios are valuation ratios used by analysts to determine whether a company is undervalued or overvalued. are valuation ratios used by analysts to determine whether a company is undervalued or overvalued.

PE ratio signifies the amount of money a buyer is willing to pay for 1 rupee of company’s earnings.

Similarly, P/BV signifies the amount of money a buyer is willing to pay for 1 rupee of company’s book value.

The following table contains valuation ratios of Dr Reddy’s and Sun Pharma.

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PE and P/BV ratios of Dr Reddy’s are 37.3 and 4.1 respectively while the five-year average is 32.8 and 3.4 respectively.

In the case of Sun Pharma, PE and P/BV ratio is 52.1 and 2.6 while the five-year average of these valuations is 37.8 and 3.2 respectively.

On the P/E front, both companies are trading higher than their five-year average. However, Sun Pharma is trading at a lower P/BV than its five-year average while Dr Reddy’s is trading at a higher P/BV than its five-year average.

Research & Development (R&D): A Critical Catalyst

The success of any pharma company depends on the product portfolio it offers.

To develop a strong and robust product portfolio, a company needs to invest heavily in R&D. The R&D expenditure reflects the company’s commitment towards the growth of its business.

In the financial year 2021, Dr Reddy incurred an R&D expense of ₹16.5 bn or 8.7% of its total sales. R&D expenditure of the company increased by 7% on a YoY basis.

Sun Pharma spent ₹21.5 bn on R&D which is equivalent to 6.5% of its total sales. R&D expenditure of the company grew by 9.1%.

R&D expenditure of Sun Pharma reflects its goal of developing specialty generic drugs whereas Dr Reddy R&D expenditure signifies its efforts to augment its biosimilar portfolio.

Acquisitions and joint ventures

Both the companies have expressed to grow organically through sales and capital investments and inorganically through acquisitions.

Sun Pharma follows a very simple acquisition strategy of either consolidating its market position or strengthening its portfolio.

Since 2016, Sun Pharma has made several acquisitions to strengthen its position in various markets and therapeutic areas.

It acquired 14 brands from Swiss multinational Novartis to enter the Japanese market. In 2019, the company acquired Polar pharma based out of Japan to strengthen its presence in the global dermatology market. To strengthen its branded ophthalmic portfolio, it acquired US based Ocular technologies and Sarl in 2016.

The scale of Dr Reddy’s acquisitions is nowhere near that Sun Pharma. The company has expanded organically for a large part of its history.

However, in the financial year 2021, the company acquired Wockhardt’s branded generics business in India and a few international territories.

Through this acquisition, Dr Reddy’s inherited a portfolio of 62 products across various therapy areas. The deal was sealed at an upfront cash payment of ₹14.8 bn.

Impact of Covid-19

With the onslaught of Covid, the number of prescriptions dropped significantly which led to a decline in net sales of generic medicines across the world. On top of that, the supply chain was disrupted too, leading to capital being locked up in inventory.

Indian pharma companies, the largest exporters of generic medicines, found themselves in a difficult spot.

Medicines were declared as essential items and manufacturing of medicines was permitted. Pharma companies quickly pivoted to manufacturing covid drugs to help the nation as well as themselves. Indian pharma companies tied up with prominent drug producers to manufacture and sell covid drugs to India.

Dr Reddy’s tied up with Gilead sciences and Fujifilm chemicals for a non-exclusive license to manufacture and sell Covid drugs like Remdesivir and Favipiravir. It collaborated with India’s Defence Research and Development Organization (DRDO) labs to develop indigenous therapy for Covid 19 which goes by the name of 2-Deoxy-D-Glucose.

The company partnered with Russian Direct Investment fund (RDIF) to distribute Russia’s Sputnik V vaccine in India.

It had signed non-exclusive agreements with Merck Sharp and Dohme (MSD) and Elli Lilly to manufacture and sell Covid drugs Molnupiravir and Baricitinib.

Sun Pharma supplied drugs like Remdesivir, Itolizumab, Hydroxychloroquine (HCQS), Favipiravir, and Liposomal Amphotericin B in the Indian market for treatment of Covid-19.

Sun Pharma also partnered with Elli Lilly for a non-exclusive license to manufacture and sell Baricitinib.

Future prospects

Following the outbreak of Covid, when supply chains were disrupted, it was then the Indian government realized the industry’s over-dependence on China for APIs – a prerequisite for finished formulations – and other pharma products.

The Indian government rolled out production linked incentive (PLI) schemes to incentivize domestic production of 41 pharma products. The government allocated ₹70 bn towards the scheme which will be disbursed over a period of 6 years. Also, the government has set aside ₹30 bn for building 3 bulk drug parks.

Considering these initiatives, the Indian pharma industry is set to grow multifold.

The US is the biggest market for the Indian pharma companies followed by India. The US pharma market is expected to grow at a CAGR of 2-5% for the next five years. The Indian market is expected to grow at a CAGR of 7.5-10.5% during the same period.

Specialty products, complex generics, biosimilars across oncology, immunology, and novel therapies like gene therapy will be prominent demand drivers in both these markets.

Dr Reddy’s and Sun Pharma, both are poised to benefit from the government initiatives and growth in markets where they have a strong foothold.

Dr Reddy’s focus on developing a strong pipeline of biosimilars and Sun Pharma’s focus on developing specialty and complex generic across chronic therapeutic areas could help them register their highest ever growth in the coming years.

On the contrary, one problem could stall their growth. Manufacturing facilities of the pharma companies are regularly audited by USFDA. These audits are concluded with a recommendation from USFDA which determines the capacity utilization of the plant.

Any critical observation from USFDA would dampen capacity utilization. Manufacturing facilities of Dr Reddy’s and Sun Pharma have been issued some observations in the past.

USFDA inspected the Halol facility of Sun Pharma and concluded with 8 observations. These observations refrain the company from manufacturing drugs which got approved post inspection.

The company claims to have resolved the issues and is awaiting re-inspection of the facility which has been delayed due to pandemic induced travel restrictions.

Some of Dr Reddy’s facilities were also issued some observations in 2015 but all the issues were resolved by the company. This was confirmed by the USFDA in 2020. The observations were subsequently revoked.

Equitymaster’s view

We reached out to Tanushree Banerjee, Co-head of Research at Equitymaster for her view on both companies. Here’s what she had to say…

In the wake of Covid-19, India emerged as a global leader in pharmaceutical production. Companies in India have been at the forefront of not only vaccinating citizens but also exporting Covid-vaccines to the world.

But India faces competition from China for the supply of APIs at a lower cost. The country imports 70% of the APIs from China. This high dependence on Chinese APIs has prompted the government to review and overhaul the API sector.

Going forward, domestic API production and tie up with global pharma majors could be a big tailwind for Indian generic majors.

Which is better?

For the last five years, Dr Reddy’s has outperformed Sun Pharma on majority of financial metrics except for net profit margins.

On the valuation front, Sun Pharma is relatively trading at a lower P/BV. At the same time, it’s trading at a higher P/E compared to that of Dr Reddy’s even though Dr Reddy’s had registered robust growth in its earnings.

As per the current financials of these companies, Dr Reddy’s seems to be a stronger player than Sun Pharma.

But a key point to note here is that Sun Pharma has 44 manufacturing facilities. This is far greater than Dr Reddy’s 9 facilities. Sun Pharma’s higher capacity could be a game changer and could turn the tables in its favour.

Each of the two companies is tackling price erosion in its own way. Sun Pharma is betting big on specialty and complex generics. Dr Reddy’s is focusing on biosimilar and CDM services. These strategies could offset the effect of price erosion. Should it fail, their ROCE may drop.

This analysis might have made things simpler for you. But we strongly recommend you check the fundamentals of the stock before investing.

Since stocks from the pharma sector interest you, check out Equitymaster’s powerful stock screener to find the best pharma companies in India.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. 

This article is syndicated from Equitymaster.com