Stock of the week: Dr.Reddy’s Laboratories Limited

Dr.Reddy’s Laboratories Limited is a vertically integrated pharmaceutical company with presence in more than 100 countries. It has recently become India’s top pharmaceutical company in terms of turnover and profitability.

Brief company history:

The company was established in 1984 with a modest capital of Rs.25 lacs by Dr. Anji Reddy. Within a couple of years, the company went public and also entered international markets. In 1993 it started drug discovery program by establishing Dr.Reddy’s Research Foundation. By 1994 a GDR (Global Depository Receipt) issue was successfully made (worth US$ 48 million). In 1999 Dr.Reddy’s acquired American Remedies Limited, an Indian pharmaceutical company. In 2001 it acquired BMS Laboratories Limited and Meridian Healthcare in United Kingdom. It got listed at New York Stock Exchange (NYSE) in April 2001, becoming the first pharmaceutical company in Asia Pacific region outside Japan to be traded. By December 2006 its revenues touched USD 1 billion.

Business Overview:

Dr.Reddy’s has six main areas of businesses:

• Active pharmaceutical ingredients (bulk actives and key intermediates)
• Generic pharmaceuticals (therapeutic equivalents of reference branded drugs)
• Speciality pharmaceuticals (dermatology)
• Branded formulations
• Biogeneric formulations
• Custom pharmaceutical services, including project management, R & D, formulations etc.

Some of the popular products include Ciprofloxacin, Ibuprofen, Ranitidine, Aquaderm etc. to name a few.

Dr.Reddy’s net revenues were worth USD 1.5 billion during the financial year 2006 – 07, 41% of which came from branded formulations and 34% from active pharmaceutical ingredients. North American and European markets accounted for 44% and 23% respectively. So the company is a global player in pharmaceuticals industry. Its main brands, Omez (Omeprazole), Nise (Nimesulfide), Ciprolet (Ciprofloxacin), Enam (Enalapril), and Ketorol ((Keterolac Tromethamine) together contribute more than USD 100 million to the total revenue.

In India, the stock is a constituent of both BSE Sensex (Free-float market capitalization: Rs.7830 crores; weightage: 0.84%) and Nifty (FFMC: Rs.10,655 crores; weightage: 0.45%). As mentioned earlier, the stock is also listed at New York Stock Exchange (Symbol: RDY) since April 2001.

The weekly chart of RDY at NYSE is displayed below. (Data Source: Yahoo! Finance)

A “symmetrical triangle” chart pattern has been formed in the medium term chart as shown above. Note that the stock attempted to break its previous high at 19.06 but failed. It can also be seen that, during the downtrend, higher lows and lower highs are formed. Symmetrical triangles are regarded as areas of indecision. As higher price levels are reached, selling starts to push them lower whereas some bargain buying takes place when stock hits support trendline. It can also be noted that bearish breakout has not occurred yet. Only a close below the support trendline will confirm such a breakout. Similarly, in case of uptrend, a close above resistance trendline with volumes will confirm upper side breakout.

Let us now discuss the short term trend using daily chart with NSE data.

I have written in my earlier articles about Fibonacci retracement levels. 38.2% and 61.8% retracement levels are very important and these levels should act as strong support or resistance during downtrend or pull back. 50% is strictly not a Fibonacci support but it is the average of 38.2% and 61.8% and many people consider this level also an important one. In the above chart, volumes are hidden to maintain clarity. During the first uptrend from 601 to 752 we don’t see a clear wave formation i.e. consistent higher highs and higher lows (it may not always be the case with every stock, but good trending stocks always show these most of the time). It can also be seen that during the corrective decline, at first 38.2% acted as a support; once low went below this level, stock tended to recover. But after some consolidation it once again fell further. We can see that the stock closed below 61.8% retracement. The pullback rally was again shortlived, taking the stock to nearly its support level at 601. Similar type of formation can be seen in the next wave pattern too; it has closed below 61.8%. The level of 601 is very critical. A close below this will favour further downtrend.

What are the technical indicators suggesting? Let us see some of them.

• The stock is trading well below its 50 DMA (50 day exponential moving average), 100 DMA and 200 DMA
• 10 day, 15 day and 21 day momentum (rate of change of price) indicators are all negative
• The Wilder’s DMI (directional movement indicator) favours further downtrend; -DI is above +DI and ADX is rising from a trough.

It is safe to classify the stock as “bearish” for the short term as none of the main technical indicators suggests clear uptrend, though, ideally, one would like to see the support getting broken in order to confirm.

The long term outlook in monthly charts suggests that the stock is likely to correct further.

In my earlier article “India stock market traps” I had mentioned about Elliott wave thoery. In the above chart, one can watch waves 1 through 5 during the uptrend. The correction from top of wave 5 (wave a) was extremely sharp; it nearly tested the support at 299.53, low of wave 4. As we saw with daily chart, it broke 61.8% retracement. The pullback wave ‘b’ has managed to take the stock above its previous high. However, watch the long upper shadows at the top of the trend indicating selling pressure. Now wave ‘c’ is in progress, meaning further downtrend is likely. The stock has also closed below 665.70 (38.2% retracement) and next support is at 527 (61.8% retracement).

Conclusion:

Dr.Reddy’s declared a whopping net profit of Rs.1177 crores for financial year 2006 – 07 as against Rs.211 crores, Rs.65.5 crores and Rs.283 crores for the previous years. The stock reached a high of 889 in December 2006. So this performance was already discounted by the market.

We have seen that the short, medium and long term trends are bearish. So, we can arrive at the following conclusion.

• Long term investors, particularly those who bought the stock 10 or 15 years ago, can safely exit the stock at higher levels.
• Medium term trend, though yet to be confirmed, is not likely to favour higher levels; so it is wise not to pick this stock as an investment choice.
• Short term traders need to avoid the stock as it is bearish in short term charts.

Chart Patterns and market’s reaction

Many people who follow stock markets may have noticed charts. These are graphical representation of price volume data over a period of time. It could be price plotted every hour, day, week or month and are known as hourly, daily, weekly or monthly charts respectively.

These charts are very important since the stock’s demand versus supply can be ascertained from the price action. Volume is also displayed on the charts. A visual examination of the chart will reveal how the stock moved within a particular period (day, week etc.).

It is very much essential that the investors and traders get familiar with charts, particularly those who work full time in the markets. The two common types of charts are

OHLC bar Chart (Open, High, Low, Close Charts) or Western Bar Charts

Japanese Candlestick charts

An example of OHLC bar chart:

The same chart when represented by candlesticks will look like this:

As we can see, the ‘candlesticks’ are more visually appealing compared to the OHLC bar charts.

As co-movement of price and volume gets plotted over a time, the current market status can be examined easily. In a bull market, increasing volume with increasing prices during an uptrend indicates bullishness. During a corrective decline in a bull market, we can see declining volumes with declining prices. In a bear market, increase in volume with decreasing prices can be spotted. During pullbacks in bear markets, declining volumes with increasing prices can be seen. Though volumes may not increase uniformly all the time, a trend can be observed.

Chart patterns:

These are certain types of formations in charts which indicate bullishness or bearishness. These are formed by support / resistance levels and trendlines.

Support level is the price where buyers will enter the stock and take control over the sellers. Resistance level is the price above which the stock must trade in order to move up higher.

Some of the chart patterns are:

Bullish patterns: Double bottom, triple bottom, inverse head and shoulder pattern, cup and handle breakout, triangle breakout etc.

Bearish patterns: Double top, triple top, head and shoulder pattern etc.

The daily chart of SAMTEL is shown below. Let us analyze how many chart patterns have been formed over a period of time. This is an interesting stock since this gives an idea as to how the market reacts quickly to a chart formation.

Cup and handle breakout:

Bewteen March 2001 and April 2002 watch the ‘cup’ shaped price movement followed by the ‘handle’. Watch the resistance could not be broken on the first attempt. That lead to another decline. Eventually, after the resistance at 31.50 was broken, the stock touched a high of 57.50. It can easily be noted that the green line or the ‘top’ of cup was a strong support during the corrective decline from 42.90 to 30.90.

Inverse Head and Shoulder pattern:

This bullish pattern was formed between August 2002 and November 2003. It simply looks like an inverted man.

Please note that the ‘shoulders’ may not be horizontally on the same line and this is nothing unusual. After the resistance around 32.80 was broken, see how quickly the prices were flying vertically upto 74.65. This was again followed by a corrective decline.

Double bottom:

This pattern was formed around the 38.35 which was the next resistance when the stock bounced back during the inverse head and shoulder pattern. Again, after the resistance trendline was broken, we can see the heavy buying upto 124.70. Double bottoms and triple bottoms are usually more reliable bullish patterns, indicating strong support levels.

Head and shoulder pattern:

After hitting a high of 124.70, stock fell to 84.20 and after the reversal, it was unable to pierce the ‘neckline’ as can be seen in the chart. The neckline is an important resistance zone in this pattern. Ever since this happened, stock has been terribly bearish. All supports have been broken, except for the last one at around 12.70. This is almost 1/10^th of its high price. Just imagine a person who bought it near the high price and wondering what’s going on with this. Currently it is 16.25.

Conclusion:

As can be seen from the chart, the bullish and bearish patterns, when spotted successfully, foretell how the stock will perform in the near future. In this case, the head and shoulder pattern has clearly indicated the bearishness and stock was hit very badly.

What will happen to this stock in the near future? As mentioned earlier, it just managed to bounce back near its last horizontal support around 12.70 but without much volume. Momentum indicators are negative and if it is able to sustain above the support of 12.70, we can expect a consolidation phase. But consolidation phase may last for longer durations, and as such, there is nothing this stock can offer for anyone for the time being.

When investors make a decision to buy a stock for long term investments, it is better to observe patterns such as these. That will help them to hold stocks for better returns.