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Conference call note: Dr. Reddy's - Views on News from Equitymaster
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Conference call note: Dr. Reddy's
Aug 18, 2004

Background
Dr. Reddy's Laboratories commenced operations in 1984 with a vision to sustain and improve the quality of life. The company is involved in the entire pharmaceutical chain - basic research, finished dosages, generics, bulk actives, biotechnology and diagnostics. The company has filed 64 patents and is the first Indian company to out license a molecule for clinical trial. The company has set up a research subsidiary, Reddy US Therapeutics Inc., in Atlanta - USA to strengthen its research capabilities in filing ANDA’s. The company exports bulk drugs, branded and generic formulations to over 60 countries.

In the year FY04, export contributions to the total revenues was 64%. Of this, 41% came from North American markets. The company spends about 10.2% of its revenue on R&D activities. The company's financial performance has been excellent in past few years, with revenues clocking a 29% CAGR in past 5 years and profits a 20% CAGR over the past 4 years. However, FY04 was a dampener, with revenue growth of 11% and a significant 33% dip in profits. A sharp decline in FY04 margins impacted profits. The EBITDA margin declined from 25.7% in FY03 to 14.8% in FY04.


*Figures on top of bar are percentage of sales

Key impressions
Sales woes:  The drop in sales in the US market (down 60% YoY in 1QFY05) is due to the increase in the competition in Fluxotine and Tizinatidine. The company enjoyed exclusive marketing rights (EMR) on both products for six months, but even after the EMR expiry there was no competition faced by the company for almost two years. But, off late company is facing competition in both products.

Margin outlook:  The margins are under pressure due to high fixed expenses on the marketing and distribution side in US. The company has increased R&D expenses, which too has depressed margins (10.2% of FY04 revenues). A part of this expense increase is due to in-house clinical trials of its molecules. Another part of increase has come from the increased activity on the ANDA's front. R&D activity is going on new ANDA's, which include many non-para IV filings. Dr. Reddy’s is planning to increase its non-para IV filings going forward. But the underlying focus on para IV will continue.

In the management’s view, the bulk drugs business will continue to be robust for coming quarters. However, margins of bulk drugs will be lower than the company’s formulations and generics business margins. Consequently, going forward, we foresee that margins will be lower than what the company has enjoyed in last three financial years. We foresee EBITDA margin of 12% in FY05 and 14.5% in FY06.

Future strategy:  Dr. Reddy’s is planning to explore mainland European countries like Germany and France. The company is planning to out license some of its products to already established companies for marketing. The management has clarified that it is not eyeing any acquisitions in these markets. The company is positive on the Olanzapine’s case outcome. The decision of the lower court is likely to come in mid-September.

Conclusion
Based on our inferences from the conference call, we have downgraded the company's FY05 EPS by 25% to Rs 26. Concerns over margins remain. Overall, the outlook for the company remains negative in short to medium term. However, certain changes in the strategy made by the company augur well for the long-term growth in sales and earnings. We advise caution over the short term and foresee continued weakness over the next two quarters.

However, we are optimistic on the company's future over 3 to 5 year perspective. As the company will move towards filing new ANDA’s, the company’s sales in the regulated markets will increase. Also, the UK operations may show growth going forward. In our view, the formulations business is also set to grow and on the bulk side, Dr. Reddy's is likely to retain its cost competitiveness.

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