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Dr. Reddy’s: A difficult year - Views on News from Equitymaster
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Dr. Reddy’s: A difficult year
May 21, 2008

Performance summary
  • Revenues decline by 24% YoY in FY08 owing to the high base effect in FY07, wherein the company generated revenues from the authorised generics deals and ‘Ondansetron’ exclusivity. On a like to like basis, revenues have registered a 7% YoY growth in rupee terms.
  • With the exception of raw material costs, all other expenses (as percentage of sales) witness a rise leading to an 8.6% YoY contraction in EBDITA margins for the fiscal.

  • PAT falls by 55% YoY on the back of decline in sales, contraction in operating margins. Higher other income and lower interest costs however pare some pressure from the bottomline.

Consolidated numbers
(Rs m) 4QFY07 4QFY08 Change FY07 FY08 Change
Net sales 16,755 12,920 -22.9% 64,346 49,142 -23.6%
License fees and service income 428 276 -35.6% 910 775 -14.8%
Expenditure 10,939 11,093 1.4% 48,701 41,528 -14.7%
Operating profit (EBDITA) 6,245 2,103 -66.3% 16,555 8,389 -49.3%
EBDITA margin (%) 37.3% 16.3%   25.7% 17.1%  
Other income 457 563 23.2% 1,162 2,038 75.4%
Interest (net) 141 273 93.8% 1,526 958 -37.2%
Depreciation 1,190 1,119 -5.9% 3,791 4,019 6.0%
Profit before tax 5,371 1,274 -76.3% 12,399 5,450 -56.0%
Tax 982 498 -49.3% 2,744 1,077 -60.7%
Minority interest (1) 2   4 9 145.7%
Profit after tax/(loss) 4,388 778 -82.3% 9,659 4,381 -54.6%
Net profit margin (%) 26.2% 6.0%   15.0% 8.9%  
No. of shares (m)       167.9 168.2  
Diluted earnings per share (Rs)         26.1  
Price to earnings ratio (x)         25.0  

What has driven performance in FY08?
  • Dr. Reddy’s revenues in FY08 exhibited a fall of 23% YoY. This was attributed to the supply constraints faced by Betapharm (which was acquired by Dr. Reddy’s in February 2006) in Germany and more importantly the high base effect of FY07 due to revenues from the authorised generics deals and ‘Ondansetron’ exclusivity. These were not present during the current year, thus impacting sales to that extent. Excluding the impact of authorised generics and the ‘Ondansetron’ exclusivity, revenues grew by 7% YoY in rupee terms. During the year, revenues from the API (active pharmaceutical ingredients) segment declined by 1% YoY on a consolidated basis as the company enjoyed the benefit of upsides in ‘Sertraline’ and ‘Rabeprazole’ in FY07, which was not the case in FY08. Having said that, while India and the rest of the world markets faced pressure, revenues from North America and Europe grew by 88% YoY and 19% YoY respectively, thus arresting any further decline in sales from the API segment.

  • Dr. Reddy’s revenues from the generics business (both the US and Europe) witnessed a 46% YoY decline during the year. This was largely due to the high base effect on the back of the authorised generics deals (for ‘Simvastatin’ and ‘Finasteride’) and the exclusivity for ‘Ondansetron’ in FY07 in the US. Excluding this impact, revenues from the US generics market clocked an impressive 45% YoY growth. The company launched 11 new products during the year with revenues accounting for 8% of total sales in North America. In Europe, revenues grew by a mere 1% YoY largely due to a subdued performance of Betapharm in Germany, which reported a staid 3% YoY increase in revenues during the year. It must be noted that Betapharm was impacted by the adjustment of rebate payments to insurance companies from revenues in FY08, supply constraints for a larger part of the year and pricing pressures. That said, especially during 4QFY08, the transfer of some of the products to India seems to have worked for the company in terms of easing supply pressures. This was instrumental in Betapharm managing to grow its revenues.

    Consolidated business snapshot
    (Rs m) 4QFY07 4QFY08 Change FY07 FY08 Change
    APIs 3,939 3,012 -23.5% 11,883 11,805 -0.7%
    - India 468 547 16.9% 2,077 2,351 13.2%
    - International 3,471 2,465 -29.0% 9,806 9,454 -3.6%
    Branded Formulations 2,888 3,521 21.9% 13,086 15,241 16.5%
    - India 1,608 1,992 23.9% 6,964 8,060 15.7%
    - International 1,280 1,529 19.5% 6,122 7,181 17.3%
    Generics 6,692 4,969 -25.7% 33,224 17,782 -46.5%
    - US 5,619 2,404 -57.2% 23,600 8,040 -65.9%
    - Europe 1,073 2,565 139.0% 9,624 9,742 1.2%
    Custom Pharmaceutical Services 1,945 1,362 -30.0% 6,600 4,818 -27.0%
    - Organic business 420 709 68.8% 1,200 1,880 56.7%
    - Mexico 1,525 653 -57.2% 5,400 2,938 -45.6%
    Others 108 135 25.0% 302 361 19.5%
    Total 15,572 12,999 -16.5% 65,095 50,007 -23.2%

  • In the formulations segment, Dr. Reddy’s international sales grew by a decent 17% YoY on a consolidated basis, driven by strong performances of Russia and the CIS markets. As far as the domestic business is concerned, revenues from the same grew by 16% YoY driven by key brands namely ‘Omez’, ‘Stamlo Beta’, ‘Razo’ and the launch of ‘Reditux’. Revenues from the custom manufacturing business declined by 27% YoY due to the 44% YoY fall in revenues from the Mexican business. This was attributed to the softening of demand for a key product ‘Naproxen’ due to piling up of inventories with the customers and hence the volume growth was not as high as in FY07. The organic business reported a robust 58% YoY growth and capped the decline in revenues from the overall custom manufacturing business.

  • Dr. Reddy’s operating margins contracted by 8.6% during the year. With the exception of raw material costs, all other expenses witnessed an increase (as percentage of sales). Raw material costs were lower due to the absence of authorised generics this year, as these enjoy lower gross margins. Both R&D and SG&A expenses (as percentage of sales) witnessed a rise. Besides a 10% YoY growth in the gross R&D spend, the reimbursements under its R&D partnerships were considerably lower this year than what it was in FY07. A 49% YoY drop in operating profits led to the 55% YoY dip in net profits despite the higher other income and lower interest costs. The company also reported additional amortization of certain product related intangible assets in Spain and impairment of goodwill relating to its subsidiary in Atlanta totaling to Rs 218 m during the year, which further pressurised profits.

What to expect?
At the current price of Rs 653, the stock is trading at a multiple of 17.2 times our estimated FY10 earnings. FY08 was a difficult year for Dr. Reddy’s as its performance was a mere shadow of its splendid show in FY07. Lack of product exclusivities, supply constraints and pricing pressure at Betapharm and an unenthusing performance of its custom manufacturing business; all concerted to blemish Dr. Reddy’s overall performance. While these are short-term blips, the company’s focus on a stronger product flow in the US, growth in Betapharm, custom manufacturing business and other core businesses will be the key long-term drivers. The company is focusing on building a strong pipeline in the US market with the aim of launching around 15 products in this market every year. Besides this, it is increasing its focus on biologicals as they attract higher margins due to lesser competition and complexity in manufacture.

As regards Betapharm, the company is expected to face difficult conditions in the medium term due to regulatory changes in the German market and supply constraints. But, in the long-term, Betapharm is expected to boost Dr. Reddy’s presence in the European region. We shall soon update our research report on the company.

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