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Budget Battles Boost Generics

By Benjamin Shepherd on October 15, 2013

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We’re now into day 15 of the US government shutdown, as House Republicans stubbornly try to defund Obamacare. No matter what sort of deal is eventually struck, health care costs aren’t likely to come down any time soon. And that’s good news for generic drug makers.

Dr. Reddy’s Laboratories
(NYSE: RDY) is one of the biggest players in generic drugs, offering more than 200 off-brand medications in the areas of cardiovascular disease, pain management and oncology, among others. In fact, this India-based company has become one of the largest makers of generics in the world, helping to drive more than 20 percent annual compounded earnings growth at the company over the past decade.

Drug spending is a major cost center for the government, with more than $325 billion worth of pharmaceuticals purchased last year. Less expensive but just as effective generic medications accounted for nearly 84 percent of those prescriptions, as physicians try to treat lifestyle-related diseases without breaking the bank.

In the emerging markets, health care spending is experiencing a similar explosion, as incomes have grown and standards of living improve. It is estimated that there are now at least 350 million people suffering from diabetes around the world, as obesity becomes a growing concern in virtually every region.

According to data from the International Diabetes Foundation, India and China are running neck and neck for the most sufferers of diabetes. They’re followed by the US, which falls into third place with an estimated 30 million diabetes patients alone, to say nothing of other lifestyle related illnesses such as heart disease.

As life expectancies continue to lengthen both in the US and abroad, other age-related ailments such as dementia will also become a growing concern.

That’s why pharmaceuticals account for the lion’s share of growing health care spending, with drug sales expected to reach USD550 billion annually by 2020. The only way both national governments and patients can cope with those rising costs is to continue relying on less expensive but just as effective generic drugs.

Generic drugs are typically equivalent to a branded original in terms of efficacy, but often cost less than a third than the original. As a result, emerging market consumers who typically pay for medications out of their own pockets are increasingly opting for generic drugs while in the US, insurance companies are steering consumers in that direction.

While Dr. Reddy’s products are becoming increasingly popular in the US, where it offers generic versions of drugs such as Plavix and Lipitor, the bulk of its sales are in emerging markets.

The company benefits from the fact that, thanks to its home location of India, it can manufacture its products at an extremely low cost. Its gross margin typically runs in excess of 50 percent, as drug utilization rates continue to increase even as overall spending may be in decline.

The company also invests heavily in research and development, spending between 6 percent and 7 percent of its annual revenues on developing generic versions of popular drugs while also coming up with novel products of its own. It is increasingly working in areas where there is little existing competition to introduce new drugs, an advantage that will drive the company’s long-term profitability.

The company is now pushing its geographic reach, working to grow its presence in fast growing markets such as China by expanding its sales force and working with local regulators to help smooth the approval process.

With the recent budget battle in the US reflecting growing concerns over rising health care costs, companies such as Dr. Reddy’s will continue to grow earnings at an above-average pace. That’s a major reason why Dr. Reddy’s, which has more than doubled its earnings over the past three years, has outperformed major indexes over the past the year, even as consumer staple and health care stocks have increasingly become laggards in the market.

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