Dr. Reddy’s: Consolidation woes - Views on News from Equitymaster

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Dr. Reddy’s: Consolidation woes

Aug 5, 2003

Domestic pharma major, Dr. Reddy's Laboratories (DRL) has recorded healthy growth in 1QFY04. While the topline increased by 30%, the bottomline grew by a strong 54%. However, on a consolidated basis, DRL has reported a meager 7% increase in total revenues and a 34% dip in net profits.

Consolidated results
(Rs m) 1QFY03 1QFY04 % change
Net Sales 4,385 4,696 7.1%
Other Income 131 222 69.8%
Expenditure 2,841 3,586 26.2%
Operating Profit (EBDIT) 1,544 1,109 -28.1%
Operating Profit Margin (%) 35.2% 23.6%  
Interest 15 4 -76.3%
Depreciation 172 231 34.1%
Profit before Tax 1,487 1,096 -26.3%
Extraordinary income - -  
Tax 168 219 30.1%
Profit before Minority interest 1,318 877 -33.5%
Minority interest 11 -  
Profit after Tax (Consolidated) 1,329 877 -34.0%
Net profit margin (%) 30.3% 18.7%
No. of Shares (eoy) (m) 76.5 76.5  
Fully Diluted Earnings per share* 69.5 45.9  
P/E Ratio   22.6  
* annualised      

Although DRL has improved its operating efficiency on account of a better product mix, sharp increase in the selling, general and administrative (SGA) expenses as well as in the R&D expenditure has off-set this improvement, resulting in the company recording a drop in the operating margins. R&D expenditure, which stood at 6.8% of the total revenues, has increased primarily due to an increase in the number of bio-studies in generics and higher development activity in APIs. The increase in SGA expenses, on the other hand, was on account of an increase in the legal & consultancy charges and marketing expenses. However, a sharp drop in the interest expenses coupled with an increase in the other income (due to higher fixed deposit interest income) has helped the company register a sharp rise in the bottomline on a standalone basis.

Standalone
(Rs m) 1QFY03 1QFY04 % change
Net Sales 3,350 4,343 29.6%
Other Income 166 194 16.8%
Expenditure 2,412 2,919 21.0%
Operating Profit (EBDIT) 938 1,424 51.8%
Operating Profit Margin (%) 28.0% 32.8%  
Interest 14 3 -80.4%
Depreciation 137 164 20.1%
Profit before Tax 954 1,452 52.2%
Extraordinary income - -  
Tax 153 217 41.9%
Profit after Tax/(Loss) 801 1,235 54.1%
Net profit margin (%) 23.9% 28.4%
No. of Shares (eoy) (m) 76.5 76.5  
Fully Diluted Earnings per share* 41.9 64.6  
P/E Ratio   16.1  
* annualised      

Let us take a detailed look at the consolidated revenue break-up for the company during the quarter.

Revenue mix by geography
(Rs m) 1QFY03 1QFY04 % change
India 1,661 1,749 5.3%
North America 1,657 1,554 -6.2%
Russia 343 435 26.8%
Europe 322 412 28.0%
Others 550 662 20.4%
Total 4,533 4,812 6.2%

On observing the geographical revenue mix we see that although the North American markets have seen negative growth, strong performance in the Russian and European markets has helped the company. The growth in the European markets was fuelled by a strong performance of new products launched in the UK.

Revenue mix by segment
(Rs m) 1QFY03 1QFY04 % change
Bulk drugs 1,753 1,655 -5.6%
Branded Formulations 1,566 1,822 16.3%
Generics 1,070 1,198 12.0%
Others 144 137 -4.9%
Total 4,533 4,812 6.2%

Bulk Drugs:
The bulk drugs segment was the only major segment of DRL that recorded negative growth. This was primarily on account of a 15% drop in revenues from the North American markets. Although there was a sharp decline in the revenues from 'Tizanidine', the drop was partially offset by growth in 'Naproxen sodium', 'Ranitidine Hcl form 1' and 'Sertraline'. The European and Indian markets also recorded a 32% and 8% decline respectively. DRL filed 3 US DMFs in the current quarter thereby taking the total filings to 43.

Branded Formulations:
Branded formulations segment was the top performer for the company. While the Indian markets registered a 15% growth, international markets saw an 18% increase.

On the international front, growth was primarily fuelled by strong performance in Russia (contributing 68% of total international branded formulations revenues). In the Russian markets, the decline in revenues from ‘Enam’ was partially offset on account of growth recorded in 'Omez', 'Ciprolet' and 'Ketorol'.

Coming to the domestic branded formulations market, strong performance in the key brands like 'Omez', 'Gaity', 'Stamlo', 'Stamlo Beta' and 'Enam' have helped DRL outperform the industry. Among the therapeutic segments, diabetic care, cardiovascular, and gastro intestinal segments were the top performers. The following table provides the therapeutic segment-wise breakup of the company’s revenues.

Therapeutic distribution of domestic revenues (% of sales)
Therapeutic segments 1QFY03 1QFY04
Gastro intestinal 18 20
Pain management 19 17
Cardiovascular 16 18
Anti infectives 12 10
Naturals 13 11
Others 22 24
Total 100 100

Generics:
On the generics front, North America contributed 81% of the total revenues, with Europe making up for the rest. In the North American market, Fluoxetine capsules 40 mg accounted for Rs 588 m, while, Tizanidine tablets 2 & 4 mg contributed Rs 200 m. In the European market, new product launches including 'Omerprazole' were the key growth drivers. During 1QFY04, DRL made 1 Para 4 ANDA filing, taking the total number of ANDAs pending US FDA approval to 24.

Others: In the other business segments that DRL operates, custom chemical services, diagnostics, critical care and biotechnology all recorded a decline. The decline in the diagnostic segment was due to the closure of diagnostic operations during the current quarter.

During 1QFY04, DRL invested Rs 151 m in Aurigene Discovery Technologies and Aurigene Inc., bringing the total investments to Rs 852 m. The company also incurred capex of Rs 456 m.

At the current price of Rs 1,037 DRL is currently trading at a P/E of 22.6x its consolidated 1QFY04 earnings. In view of the DRL’s increased focus on generics as well as new drug discovery research, US government’s thrust on promoting generics and the likely approval of Amlodipine Maleate, the future prospects of the company look positive. However, the risks inherent in drug discovery and the mounting legal expenses incurred while challenging existing patents remain. Hence, the investor must not base his decision on the outcome of a single court ruling.


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