Dr Reddy's: Dismal performance - Views on News from Equitymaster

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Dr Reddy's: Dismal performance

May 29, 2004

Dr Reddy's announced poor March quarter and FY04 results yesterday. The net sales of the company were down 1.4% in 4QFY04, while net profit was down by 91% on a standalone basis. The company incurred operating loss of Rs 195 m. The performance for the full year too, was not very encouraging, with net profit plummeting by 29% to Rs 2,830 m. Although revenues of the company in FY04 were up 9%, the operating profit of the company fell by 33% YoY. The operating margins plummeted to 18% compared to 29.4% in FY03.

(Rs m)4QFY034QFY04ChangeFY03FY04Change
Net sales4,026 3,969 -1.4%15,286 16,666 9.0%
Other income139 159 14.0% 465 757 63.1%
Expenditure2,830 4,164 47.1%10,796 13,658 26.5%
Operating profit (EBDITA)1,196 (195)-116.3% 4,490 3,008 -33.0%
Operating profit margin (%)29.7%-4.9%  29.4%18.0%  
Interest 5 6 24.0%35 15 -57.1%
Depreciation164 201 22.8% 608 717 17.9%
Profit before tax1,167 (243)- 4,312 3,033 -29.6%
Tax(29) (351)- 391 202 -48.4%
Profit after tax/(loss)1,196 107 -91.0% 3,921 2,832 -27.8%
Net profit margin (%)29.7%2.7%  25.7%17.0% 
No. of shares (m)      76.5 76.5  
Diluted earnings per share (Rs)*      51.3 37.0  
(* annualised)           

On consolidated basis, revenues increased by 12% YoY and the net profit was down 31%. Dr. Reddy's consolidated operating margin stood at 14.8%, down from 25.2% in FY03. The company's dismal performance has come on back of its poor showing in the North American markets.

Consolidated…
(Rs m)FY03FY04Change
Net sales 17,289 19,334 11.8%
Other income538 894 66.0%
Expenditure 12,927 16,471 27.4%
Operating profit (EBDITA)4,362 2,863 -34.4%
Operating profit margin (%)25.2%14.8% 
Interest 39 19 -51.4%
Depreciation751 1,025 36.4%
Profit before tax4,110 2,713 -34.0%
Tax461 202 -56.2%
Profit after tax/(loss)3,649 2,511 -31.2%
Net profit margin (%)21.1%13.0%  
No. of shares (m)76.5 76.5  
Diluted earnings per share (Rs)*47.7 32.8  
P/E ratio (x)  27.0  
(* annualised)      

Operating expenses expanded at a faster clip as compared to revenues. The raw material costs went up by a substantial 23%. Consequently, raw material cost as a percentage of revenues went up from 30% to 34% mainly on account of increased contribution of API's in the total business. The company has also increased the R&D expenses in FY04 by about 38% YoY. R&D expenditure now stands at 9.9% of total revenues compared to 7.8% in FY03, the highest among Indian companies. A one-time charge of Rs 385 m on amolodipine project and government charges also reduced the company's margins substantially. The following table shows the cost structure of the company on a consolidated basis.

Cost structure consolidated…
Rs mFY03FY04Change% of sales FY04
Raw material4,976 6,208 24.8%32.1%
Staff cost1,794 2,366 31.9%12.2%
Excise duty expenses153 59 -61.5%0.3%
R&D Expenses1,324 1,826 37.9%9.4%
Selling Expenses1,594 1,968 23.4%10.2%
Provisions35 --100.0%0.0%
Other expenditure3,052 4,045 32.6%20.9%
Total129271647127.4%85.2%

Dr. Reddy's dismal performance can be attributed to the change in the business mix. The low margin API business has outpaced the branded formulation and generics business in the fourth quarter as well as in the full year. Infact, on a consolidated basis, the API business has grown by 20%, while the generics business grew by a marginal 1%. It should be noted that in API business, which is more like a commodity business, margins are considerably lower compared to generics or formulations business. The generics business of the company took a toll in the US because of increasing competition in Fluoxetine and Tizanidine tablets. Also, the lack of new product launches in the US also contributed to the woes of the company. The amolodipine setback was also a negative for its generic plans. While the generics business of the company in US has come down by 9% in FY04, the company was able to expand its business in the European markets and Russian markets.

Business mix consolidated…
FY03FY04Change% of sales FY04
APIs6,341 7,629 20.3%39.5%
Branded Formulations 6,860 7,507 9.4%38.8%
Generics4,284 4,338 1.3%22.4%
Diagnostic and other services428 411 -4.0%2.1%
Others157 297 89.2%1.5%

In the Indian market, Dr. Reddy's was able to outperform and grew by 10% compared to 7.3% growth in overall market. The key brands of the company have shown good performance and were led its growth in the Indian markets. These brands contributed 52% of the total branded formulation sales of the company. It should be noted that the branded formulations market in India had a good time in FY04 compared to a very lean period in FY03.

Dr. Reddy's high-risk business of patent challenges has cost it dear in FY04, with no success after fluoxetine. Notwithstanding this, the company has filed 13 ANDA's with USFDA in FY04, out of which 8 were Para IV filings, which again shows the company's aggressiveness in the US market. At the current price of Rs 887, the stock is trading at a P/E of 27x FY04 earnings, which seems to be on a higher side with a near term view. The margins of the company in FY05 are unlikely to improve substantially, since Dr. Reddy's is not gaining any ground in generics and formulations. On the positive side, increased R&D expenses reiterate the company's focus on research, a key factor for success over the long term. Also, the acquisition of Trigenisis in the US will enable the company to enter the lucrative dermatology market in the US, which can drive revenues further. In the near term, investors should view the stock with caution considering the company's high risk strategy of patent challenges, which makes its performance prone to volatility. Over the long term, we remain positive on Dr. Reddy's prospects considering its research strengths.

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