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Dr. Reddy’s: On the recovery path? - Views on News from Equitymaster
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Dr. Reddy’s: On the recovery path?
Jul 29, 2005

Performance summary
Dr.Reddy’s announced strong results for the first quarter ended June 2005. Increased price realisations in the European markets and strong growth in the branded finished dosage segment in India have aided the topline growth during the quarter. This coupled with a drop in R&D expenditure, on account of the partnership with ICICI Venture, has enabled the company post a healthy bottomline growth.

Consolidated numbers
(Rs m) 1QFY05 1QFY06 Change
Net sales 4,682 5,382 15.0%
License fees and service income - 16  
Expenditure 4,353 4,752 9.2%
Operating profit (EBDITA) 329 646 96.4%
EBDITA margin (%) 7.0% 12.0%  
Other income 159 239 50.3%
Interest (net) 48 35 -27.1%
Depreciation 278 348 25.2%
Profit before tax 162 502 209.9%
Tax 3 194  
Minority interest 5 (1)  
Profit after tax/(loss) 164 307 87.2%
Net profit margin (%) 3.5% 5.7%  
No. of shares (m) 76.5 76.5  
Diluted earnings per share (Rs)* 8.6 16.1  
Price to earnings ratio (x)   52.3  
(* annualised)      

What is the company’s business?
Dr. Reddy's Laboratories is a leading pharmaceutical company in the country, having a presence across the pharmaceutical value chain - basic research, finished dosages, generics, bulk actives, biotechnology and diagnostics. The company has filed 64 patents till now and is the first from India to get an Exclusive Marketing Right (EMR) in the US market for Fluoxetine Axetil. The company exports bulk drugs, branded and generic formulations to over 60 countries. Active Pharmaceutical ingredients (API's) constituted 40% of the company's business in FY05. Formulations business is another big contributor to revenues (44%). Its generics business in regulated markets contributed 13% and the rest came from diagnostic, critical care and biotechnology business.

Standalone numbers
(Rs m) 1QFY05 1QFY06 Change
Net sales 4,013 5,129 27.8%
License fees and service income - 6  
Expenditure 3,602 4,236 17.6%
Operating profit (EBDITA) 411 899 118.7%
EBDITA margin (%) 10.2% 17.5%  
Other income 146 228 56.2%
Interest (net) 46 32 -30.4%
Depreciation 200 261 30.5%
Profit before tax 311 834 168.2%
Tax 2 200  
Profit after tax/(loss) 309 634 105.2%
Net profit margin (%) 7.7% 12.4%  
No. of shares (m) 76.5 76.5  
Diluted earnings per share (Rs)* 16.2 33.2  
Price to earnings ratio (x)   25.3  
(* annualised)      

What has driven performance in 1QFY06?
Revenues grow at a healthy pace:  Dr.Reddy’s standalone revenues staged a recovery in 1QFY06 and posted a healthy 28% YoY growth on a standalone basis. It must be noted that the formulations business clocked a robust 35% YoY growth. In India, higher demand from trade channels following lower off take in 4QFY05 due to uncertainty over the implementation of VAT, contributed to the topline growth. Also, a 47% YoY growth in the international branded formulations business (Russia, CIS, Central Europe etc.) contributed to the overall growth in formulations.

API business grew by 15% YoY on the back of new product launches and volume growth in existing products in international markets. However, in the European markets, ‘Ramipril’ continued to face pressure. It must be noted that in the previous quarter (4QFY05), the company’s sales in the European markets were severely affected owing to the decline in “Ramipril’ sales.

Standalone business snapshot
(Rs m) 1QFY05 1QFY06 Change
APIs and Intermediates 1,769 2,025 14.5%
PBIT margin (%) 11.7% 7.3%  
Formulations 1,933 2,606 34.8%
PBIT margin (%) 43.9% 41.7%  
Generics 429 645 50.3%
PBIT margin (%) 25.9% -0.8%  
Critical Care and Biotechnology 84 133 58.3%
PBIT margin (%) -10.7% -15.0%  
Total gross revenues 4,215 5,409 28.3%
PBIT margin (%) 18.4% 18.3%  

Generics business (12% of revenues in 1QFY06) rose 50% YoY propelled by the growth in its key products of ‘omeprazole’ and ‘amlodipine maleate’ in the European markets. Higher price realisations due to shortages in supply in the market led to higher sales of these products. Apart from this, continued strength in the company’s critical care and biotechnology business (though small) was also a positive.

However, US operations continued to remain under pressure. Decline in revenues from ‘fluoxetine’ and ‘tizanidine’ owing to intense competition from existing as well as new players resulted in a drop in the revenues from the US markets.

Cost break-up (Standalone)
(as % of sales) 1QFY05 1QFY06
Raw material 37.9% 35.1%
Staff cost 11.0% 10.1%
R&D expenses 14.0% 8.7%
Selling expenses 10.1% 11.0%
Other expenditure 16.7% 17.7%
Total 89.8% 82.6%
Improvement in margins:  Operating margins of the company expanded by an impressive 730 basis points owing to higher contribution from branded finished dosage sales to total revenues and better price realisations in the European markets. Also, the company witnessed a sharp drop in its R&D expenditure. This was on account of the partnership entered into with ICICI Venture, in a bid to mitigate the risk of high R&D and litigation costs with respect to ANDAs filed in the generics markets. However, selling expenses as a percentage of sales increased on account of increase in marketing expenses primarily in the branded finished dosage segment.

Bottomline doubles:  Strong topline performance, improvement in operating margins and higher other income trickled down to the bottomline, which registered a steep 105% YoY growth despite a significantly higher tax outgo.

Over the last few quarters...
(%) 4QFY04 1QFY05 2QFY05 3QFY05 4QFY05 1QFY06
Net sales growth -1.4% 0.5% 0.1% -9.4% -10.3% 27.8%
Operating profit margin -4.9% 7.0% 13.3% 2.2% -4.4% 17.5%
Net profit growth -91.0% -83.0% -47.7% - - 105.2%

What to expect?
At the current price of Rs 839, the stock is trading at 43.2 times our estimated consolidated FY07 earnings, which is rather rich. Dr.Reddy’s has performed well in this quarter showing encouraging signs of recovering after a poor show in the last five quarters. On the R&D front, the partnership with ICICI Venture has started to reap benefits, which has consequently eased the pressure on the company to a certain extent. Off late, the company has changed its high-risk strategy of Para IV filings (to some extent) and is now considering other options such as entering into the specialty segment. All these initiatives are likely to benefit the company in the long run.

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