Dr. Reddy's Laboratories

President Donald Trump announced on July 21 that generic drugs imported to the US will face a 100% tariff for one year starting in August 2028 and 200% thereafter. The shares of all generic drug manufacturers under our coverage are trading down on the news.

Why it matters: The announcement, made on Truth Social, came as a surprise to us, especially after the administration's friendly stance on the generics industry last year, in contrast with branded pharmaceuticals, which faced separate tariffs. Over 90% of prescriptions in the US are filled with generic drugs, with the majority of them imported from countries like India and China. The generics industry in the US typically faces year-over-year price erosion from stiff competition, leading to weaker margins compared with branded counterparts. With inflated cost of living and rising healthcare expenditures becoming an increasingly important focus for the upcoming midterm elections, we question how the implementation of tariffs is aligned with the current administration's agenda.

The bottom line: We are not making any fair value estimate changes to the generics manufacturers we cover—Dr. Reddy's, Teva, Sandoz, and Viatris—as the situation remains highly fluid with many potential changes over the next two years. Onshoring manufacturing for generics would be a significant challenge for many manufacturers, which operate on slim margins. While we have seen certain players in the industry signal domestic investments and manufacturing expansion over the last year, we do not expect the majority of generics firms to follow suit, considering the cost challenges. Given the back-and-forth dynamics that many other industries underwent since the initial introduction of tariffs in April 2025, we expect a similar playbook for generics in the near and midterm.

We lower our fair value estimate to $12.50 per share from $14 for no-moat Reddy's to account for a weak start to fiscal 2027 and worsening INR/USD. Our valuation implies 15.8 times EV/2027 adjusted EBITDA.

Our fiscal 2027 estimates include a 7% revenue growth, supported by strong international presence, and a pullback in EBITDA margins to account for reduced contribution from lenalidomide sales in the US and semaglutide disruption impacting sales in the first half of the year.

Over our five-year forecast period, we expect an 8% CAGR for sales and EBITDA margin to climb to mid-20s from three main drivers. First, Reddy’s has committed to increase its presence in complex injectables. Complex generics, especially injectables, are more challenging to manufacture compared with small-molecule oral tablets. Therefore, the competition in this market is usually less severe, leaving more opportunities for manufacturers like Reddy’s to earn healthy profits. Furthermore, a meaningful portion of its pipeline is made up of injectables and sterile products. We expect a similar level of the company’s research and development spending to be attributed to this market.

Second, Reddy's has been investing in its biosimilar pipeline. Biosimilars have been seen as a growth engine for large, capable generic drug manufacturers due to comparatively higher price durability exhibited after launch and fewer competing manufacturers. About 20% of Reddy’s R&D goes to biosimilars today, but we expect this proportion to grow as the company focuses more on this portfolios of drugs. Most of Reddy’s’ capital expenditures in the last number of years went to complex injectables, sterile products and biologics, and we believe those products will continue to be the main focus of the company going forward.

Lastly, Dr. Reddy's has been shopping around to bolster its over-the-counter portfolio. In 2024, the firm has acquired a nicotine replacement therapy portfolio from Haleon and signed a joint venture license with Nestle to develop and commercialize nutraceuticals in India. We think these efforts will compliment the firm's growing OTC division and expect more tuck-in deals in the next three years.

We assign Dr. Reddy’s Pharmaceutical a no-moat rating because we do not believe the company possesses any structural advantages strong enough to earn excess returns and generate return on invested capital above its cost of capital over the next 10 years.

While generic drugs were around in the US since the early 20th century, the industry experienced significant growth following the passage of the 1984 Hatch-Waxman act. The legislation facilitated the drug application process for generic drug manufacturers by providing them a safe harbor from patent infringement litigation from branded drug manufacturers and allowed the US Food and Drug Administration to approve applications for generic drugs with abbreviated new drug applications. An ANDA requires the applicant to demonstrate its generic drug’s pharmaceutical equivalence and bioequivalence to the reference drug, but it generally does not require preclinical and clinical data to prove safety and effectiveness since it relies on the FDA’s prior approval of the reference drug’s safety and effectiveness. Overall, this legislation paved a much swifter way for generics manufacturers to get their drugs approved compared with a new drug application that a new branded drug must go through.

The US generic drug industry enjoyed another boost when Congress enacted a series of amendments named the Generic Drug User Fee Amendments (GDUFA) (first one passed in 2012, second in 2017 and the latest in 2022), allowing the FDA to collect fees from ANDA applicants to expedite application approval process. The fees (an ANDA fee rate for 2023 was around $240,000) are not meaningful enough to sway big generic manufacturers away and they also provide additional revenue streams and financial support to the FDA, allowing applications to be approved more quickly and efficiently.

These regulatory pushes by the US government paved ways for the industry to be highly competitive and filled with commoditized products, eroding a lot of pricing power that generics manufacturers once had. And although there are few players that make up a relatively healthy share of the generics market, barriers to entry here are quite low, expanding possibilities for firms in the space to face additional competition going forward. This explains the hike in generic dispensing rate (percentage of prescriptions dispensed with a generic rather than a branded reference drug) which grew from about 50% in 2000 to over 90% today.

Beyond government actions, generics manufacturers also face pressures from players within the drug supply chain. The formation of powerful generic sourcing groups and establishment of generic formularies by pharmacy benefit managers enabled drug distributors and drug buyers to effectively negotiate lower generic prices, hurting manufacturers’ margins.

Three large generic sourcing programs that were formed as joint ventures between large wholesalers and drug purchasers—ClarusONE (2016; McKesson plus Walmart), Red Oak Sourcing (2013; Cardinal Health plus CVS) and Walgreens Boots Alliance Development (2012; AmerisourceBergen plus Walgreens)—have acted as additional headwind for generics manufacturers. These entities were created to lower generics acquisition costs through the aggregation of purchasing power and as a result, they can demand higher buy-side discounts and rebates from generics manufacturers, ultimately eating into their profits. They now purchase roughly 80% of all generics sold in the US. Additionally, the interchangeability between generics has facilitated the establishment of generic formularies, in which wholesalers can use their purchasing scale to negotiate deeper concessions for placement in the generic sourcing program. As these three players continue to make up a larger portion of generic sourcing in the country and enhance their buying power, generics manufacturers are left with no other choice but to face the burden, resulting in a low- to mid-single-digit price erosion in the market year over year.

Generics make up over 80% of Dr. Reddy’s total sales and despite the company’s exposure to the branded generics market with its presence in India, Russia, China and certain Latin American countries, we believe the company is highly susceptible to all the pricing headwinds mentioned above. Dr. Reddy’s has decided to combat this by rationalizing and optimizing its portfolio, carefully deciding which drugs to continue commercializing and which drugs to discontinue. The company opted to exit spaces where it had too many existing players and discontinue small-molecule drugs that are fairly simple to be FDA-approved and to be replicated. Furthermore, Dr. Reddy’s has continued to pursue more opportunities in complex generics and biosimilars that can have a meaningful impact on the top and bottom line. These drugs typically face limited competition due to a more complicated level of research and development required before reaching commercial stage. Instead of being available in simple oral tablets, which are relatively easy to replicate by competitors, complex generics and biosimilars usually come in injectables, inhalers, and other different forms that pose more challenges to other manufacturers to produce.

Despite these efforts, we don’t believe Dr. Reddy’s has any structural advantages over other generic manufacturers. It doesn’t have a meaningfully larger number of first-to-file launches compared with other players in the space. And even if it launches a few drugs that are first to market and gain 180-day exclusivity periods in certain products, they are likely to face direct competition as soon as that period expires, leading to significant volume reductions. If Dr. Reddy’s continues to downsize its portfolio of commoditized and easy-to-replicate generic drugs and replace them with more innovative medicines, we could potentially revisit our analysis. But for now, we do not believe Dr. Reddy’s earns a moat rating.

Dr. Reddy's touts a strong track record of new launches across markets, and we expect this to continue over the medium term.

Biosimilars are poised to show promising growth as many big-name biologics lose their patents in the next five years, and Dr. Reddy’s is well positioned to enjoy this trend in emerging markets with its pipeline.

Dr. Reddy's strong branded generic presence in markets like India provides significant growth opportunities with less price competition than typically seen in developed markets.

Base business erosion will continue to persist in developed markets and act as a headwind that Dr. Reddy’s must try to offset with new product launches.

Complex injectables could become a more fragmented market as other generic manufacturers focus on this space, spurring more competition and squeezing margins for Dr. Reddy’s.

Potential tariffs for generic pharmaceuticals in the US add a layer of uncertainty for the firm and the overall industry in the near and midterm.