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By Alex Halperin

Generics Make a Name for Themselves

In an otherwise lackluster pharma market, stocks like Dr. Reddy's Labs are surging. With a slather of patents set to expire, their prospects look good

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Generic-drug stocks have been making brand-name gains. One notable example: Dr. Reddy's Laboratories (RDL), an outfit based in Hyderabad, India, with generic and brand-name pharmaceutical businesses, hit a 52-week high of $27.65 on Feb. 1. That represents a sizzling 85% leap from its 12-month low of $14.91 on May 3.

While it has receded slightly from its peak, the stock's recent advance, along with those made by larger generics companies like Barr Pharmaceuticals (BRL) and Teva Pharmaceutical Industries (TEVA), highlights this solidly growing segment of the otherwise moribund pharmaceutical sector.

STRENGTH IN DIVERSITY.  Founded by Anji Reddy in 1984 with an initial stake of $160,000 (according to the company), Dr. Reddy's went public in the U.S. in 2001 and has annual revenues of about $470 million, paced by sales of generics like fluconazole, an antifungal agent.

Dr. Reddy's stock performance owes, no doubt, to the company's improved year-over-year revenues for each of the last three quarters. But that may be only one part of the story. The generic is also involved in diversification efforts that could buoy it against larger competitors.

Ian Platts, the editor of a generic-drug newsletter published by British market researcher Espicom Group, wrote in an e-mail that Dr. Reddy's has, at least to some degree, found a way to counter the effects of the highly competitive generics market in North America: emphasizing its global reach. As its U.S. income has slipped due largely to pricing pressure, the company has posted improved numbers in countries as disparate as China, Turkey, and Mexico.

THE ROCHE CONNECTION.  Dr. Reddy's could not be reached for comment, but Platts wrote that the company still has the potential to compete well in North America and has filed 51 generic-drug applications with the U.S. Food and Drug Administration.

The bulk of these applications will be financed with assistance from ICICI Venture, the private-equity arm of India's largest financial-services group. According to a statement from Dr. Reddy's, ICICI will cover development and legal costs associated with commercializing most of the company's generic drugs in the U.S. and will receive royalty payments on approved drugs. The agreement, Platts wrote, enables Dr. Reddy's to develop new product lines while "minimizing the risks."

Dr. Reddy's has other moves afoot to expand its nongeneric business. Platts notes that in November, Dr. Reddy's said it agreed to acquire a Cuernavaca, Mexico, facility for manufacturing active pharmaceutical ingredients from Swiss drug giant Roche. Dr. Reddy's said the deal represents an effort to boost its custom pharmaceuticals services business, which supplies the components of new drugs to the companies that actually develop them.

NO DELAYS.  Dr. Reddy's appears to emphasize diversification, including the development of its own drug pipeline, but its core generics market still holds considerable promise. Al Rauch, an analyst with A.G. Edwards who follows the generics segment -- though not specifically Dr. Reddy's -- said drugs that generated about $16 billion in sales in 2005 are coming off patent this year, more than twice the figure for last year.

These drugs constitute a potential treasure chest for the outfits who work most aggressively in their commercialization efforts. The compounds include Merck's (MRK) cholesterol drug Zocor and Pfizer's (PFE) antidepressant Zoloft.

Rauch says generics outfits are growing bolder about challenging existing drug patents. He notes that generics companies are growing increasingly capable of launching drugs aimed squarely at bigger outfits' patented offerings. One factor in the generics' favor: They now have the resources to launch products immediately after the patent protection of the major pharma's compounds ends. But major pharma groups still manage to guard their intellectual property. Recent unsuccessful attempts to bring drugs off patent include plays by generics for Pfizer's Lipitor, the blockbuster cholesterol drug.

POTENTIAL THREAT  However, "competition due to the lack of market exclusivity will put pressure on prices and bottom lines," Rauch says, and perhaps result in smaller generics players getting acquired.

SG Cowen analyst Ken Cacciator -- who, like Rauch, spoke about the generics sector but not Dr. Reddy's in particular -- sees the segment heading in a different direction, with less merger-and-acquisition activity. "We're seeing the larger [generics] companies differentiating themselves and adding market share," he says, which could hurt outfits like Dr. Reddy's in the U.S. market.

With the stakes growing for generics players, it's up to the good Doctor to show that global reach can have advantages.

Halperin is a reporter for BusinessWeek Online in New York

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