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Dr. Reddy’s: Conference call excerpts - Views on News from Equitymaster
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Dr. Reddy’s: Conference call excerpts
Aug 11, 2006

Dr. Reddy’s management held a conference call post the declaration of their 1QFY07 results to discuss the company’s performance and its growth prospects going forward. Here are the key takeaways from the call. Product launches to boost US performance: Dr. Reddy’s, as the authorised generic for Merck, launched ‘Finasteride’ (‘Proscar’) and ‘Simvastatin’ (‘Zocor’) during the 180-day exclusivity granted to Teva (‘Finasteride’ and ‘Simvastatin’) and Ranbaxy (‘Simvastatin 80 mg’). The company cornered a market share of 30% for ‘Simvastatin’ and upwards of 25% for ‘Finasteride’. We believe that these launches will considerably boost the company’s performance in the US market going forward.

Dr. Reddy’s has also benefited from the limited competition witnessed for ‘Fexofenadine’ (‘Allegra’). The company had launched this drug in the US market after the expiry of the 180-day exclusivity granted to the US-based company Barr Laboratories. The company has 10% market share for this product currently, which it expects to increase to 15%. That said, there is lack of clarity on the competitive landscape for this drug going forward.

The company also believes that it is first-to-file (FTF) for ‘Ondansetron’ (GSK Plc’s ‘Zofran’), which means that it is likely to receive 180-day exclusivity post the patent expiry in 2006. However, this is subject to US FDA approval. The company’s overall US strategy is to make this business self-sustaining and achieve critical mass over the next few years. It also plans to supplement growth through R&D partnerships and product acquisitions.

Pricing outlook in the US: Dr. Reddy’s expects the pricing pressure to continue going forward and expects price erosion to be more severe for plain vanilla generics, which generally attracts a larger number of players.

Europe, Germany and Betapharm: With the change in the healthcare reforms undertaken by the German government, the top generic companies in Germany such as Hexal and Stada have undertaken drastic price cuts. Betapharm, which was acquired by Dr. Reddy’s in February 2006, has also undertaken price cuts to the tune of 25% on some of its products. Slowdown in inventory offtake in anticipation of these changes has also affected volumes, consequently affecting Betapharm’s revenues during 1QFY07. The impact of this law and the pricing scenario in the German generics market is expected to become clearer over the next few quarters.

In Europe, at present, Dr. Reddy’s has a presence in the UK and Germany. The company intends to focus on increasing its footprint in the European markets and is now looking to make a foray into France, Italy and Spain.

Custom manufacturing to gain traction: Dr. Reddy’s had acquired Roche’s API manufacturing facility in Mexico to boost its custom manufacturing business. The company expects this business to generate revenues to the tune of US$ 100 m by FY07. This manufacturing facility has multi-year agreements with Roche, Bayer and a few other innovator companies, which are long-term in nature. The product portfolio comprises of about 18 products including a range of APIs and steroids. While part of the business is contractual, part of it is purchase-based depending on the demand from customers. Also, the revenue mix is a blend of mature APIs and development projects. The latter constituted around 15% of CPS (custom pharma services) revenues and enjoys higher margins.

R&D progress: Dr. Reddy’s expects its anti-diabetic molecule ‘Balaglitazone’ to enter Phase III clinical trials by the end of the year. The carcinogenicity studies on this molecule have been completed and the company is awaiting the results on the same.

Capex plans: As Dr. Reddy’s increases its foray into newer markets, the company’s capex requirements are set to increase. It has outlined an investment of US$ 100 m spread over a period of 18 months as capex. This will be funded through Dr. Reddy’s own borrowing capacity and by unlocking working capital.

What to expect?
At the current price of Rs 1,440, the stock is trading at a price to earnings multiple of 20.1 times our estimated FY08 earnings. Going forward, we expect Dr. Reddy’s performance to be driven by the launches of ‘Simvastatin’ and ‘Finastride’ in the US market in FY07 and revenue contribution from Betapharm and the custom manufacturing business. The custom manufacturing business is expected to scale up going forward with the acquisition of Roche’s manufacturing facility in Mexico. The formation of Perlecan Pharma will mitigate the risks and costs associated with clinical development of the molecules, consequently leading to an improvement in its margins going forward. Considering all these factors, while we remain positive on the company’s long-term growth prospects, investors need to be cautious with respect to valuations.

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