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Dr Reddy's: Yet another disappointment - Views on News from Equitymaster
 
 
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  • Oct 27, 2004

    Dr Reddy's: Yet another disappointment

    Introduction to results
    Domestic pharmaceutical major, Dr. Reddy’s, has declared its 2QFY05 results. The topline of the company has grown marginally, owing to poor sales in generics and bulk drug segments. The bottomline of the company is lower by 48% due to very high increase in operational expenses, depreciation and interest outgo.

    (Rs m) 2QFY04 2QFY05 Change 1HFY04 1HFY05 Change
    Net sales 5,236 5,242 0.1% 9,925 9,924 -0.0%
    Expenditure 4,102 4,545 10.8% 7,682 8,898 15.8%
    Operating profit (EBDITA) 1,134 697 -38.5% 2,243 1,026 -54.2%
    Operating profit margin (%) 23.8% 13.3%   22.6% 10.3%  
    Other income 225.1 139.4 -38.1% 446.7 298.6 -33.1%
    Interest 4.1 17.4 324.4% 7.7 65.4 749.4%
    Depreciation 249.2 312.1 25.2% 480.2 589.9 22.8%
    Profit before tax 1,106 507 -54.1% 2,202 669 -69.6%
    Tax 217.4 42.9 -80.3% 436.5 45.9 -89.5%
    Profit after tax/(loss) 889 464 -47.7% 1,766 624 -64.7%
    Net profit margin (%) 17.0% 8.9%   17.8% 6.3%  
    No. of shares (m) 76.5 76.5   76.5 76.5  
    Diluted earnings per share (Rs)* 46.4 24.3   44.2 16.3  
    P/E ratio (x)         44.2  
    (* annualised)            

    What’s the company’s business?
    Dr. Reddy's Laboratories is a leading pharmaceutical company in the country, which is present 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 is also the first company from India to get an Exclusive Marketing Right (EMR) in the US market for Fluxotine Axetil. The company exports bulk drugs, branded and generic formulations to over 60 countries. In FY04, export contributions to total revenues was 65%. Active Pharmaceutical ingredients (API's) constituted 40% of the company's business in FY04. Formulations business is another big contributor to revenues (39%). Its generics business in regulated markets contributes 22% and the rest comes from diagnostic, critical care and biotechnology business. The company is passing through a rough phase over the last few quarters, where profitability and sales growth have come under pressure.

    What has driven performance in 2QFY05?
    Sales:  The company's revenues have remained stagnant in 2QFY05, which is due to a huge fall in generics sales in the US market (down 16%). This drop in sales can largely be attributed to intense competition in the US market. Also, sales of Fluxotine, and Tizinadine, which were the mainstay of the company in the US market, saw a decline of 41%, as new players launched generic versions of their own. The company has not got any Para IV success after the initial success of Fluxotine. Lack of new launches has also added to the woes of the company. However, the revenues from these products saw an increase of 42% QoQ, when compared to 1QFY05.

    Segmental revenues*
      2QFY04 2QFY05 Change
    API's 2,021 1,821 -9.9%
    (as % of sales) 37.6% 33.7%  
      India 660 553 -16.2%
    (as % of sales) 12.3% 10.2%  
      International 1,361 1,268 -6.8%
    (as % of sales) 25.3% 23.5%  
    Branded formulation 1,971 2,315 17.5%
    (as % of sales) 36.7% 42.8%  
      India 1,395 1,345 -3.6%
    (as % of sales) 25.9% 24.9%  
      International 576 970 68.4%
    (as % of sales) 10.7% 17.9%  
    Generics 1,243 1,043 -16.1%
    (as % of sales) 23.1% 19.3%  
    Others 142 228 60.6%
    (as % of sales) 2.6% 4.2%  
    Total 5,377 5,407 0.6%
    *(these numbers are based on USGAAP)

    Also, revenues from bulk drugs declined by 10% as both local as well global sales came down. The decline in international revenues from API was a factor of decline in revenues from the European market (down 58%), due to lower sales of 'Ramipril', which saw tough generic competition, and price decline. However, Dr. Reddy’s has shown better performance in the branded formulations segment, which has grown by 17.5% in the quarter, which is due to better performance in the Russian and CIS markets. However, domestic market performance saw a decline, led by fall in sales of high revenue generating products from key therapeutic areas of Gastro-intestinal, cardiovascular and anti-infectives.

    Operating margins:  The lacklustre topline performance has led to an even worse bottomline performance. The operating margin of the company has come down from 23.8% in the same quarter last year to 13.3% in 2QFY05. The major reason for this is higher other expenses and increase in R&D expenses. The R&D expenses of the company have grown by almost by 25% and are now 11% of revenues. The increased R&D expenses are due to the clinical trials of one of its molecules, which the company has initiated recently. Also, intense activity on ANDA front has lead to the increased spending. The other major factor for the poor operational performance is the sales and distribution expenses, which grew almost 29% during the quarter. However, the increase in both the above mentioned expense heads should be seen as an investment for future benefits.

    Cost break-up
      2QFY04 2QFY05 Change
    Raw material 1,625 1,617 -0.5%
    (as % of sales) 31.0% 30.9%  
    R&D expenses 447 560 25.4%
    (as % of sales) 8.5% 10.7%  
    Staff cost 632 731 15.6%
    (as % of sales) 12.1% 13.9%  
    Sales and distribution expenses 399 515 29.1%
    (as % of sales) 7.6% 9.8%  
    Other expenses 999 1,121 12.2%
    (as % of sales) 19.1% 21.4%  
    Total 4,102 4,545 10.8%

    Net profit:  Owing to the woes in topline, as well as in operating margins, the net profit of the company was down by 48% YoY. Lower other income due to loss on the forex side, as against gains last year has also contributed to the woes on the bottomline front. However, lower taxes on account of tax exemption due to higher R&D expenses and new bulk drugs facility in tax-exempted area has cushioned further slide in bottomline.

    What to expect?
    At Rs 721, the stock is trading at 44.1x its annualised 1HFY05 earnings. Looking at the current valuations, the stock might seem to be overvalued. However, the long-term prospects of the company look good. The last three quarters for the company have been very poor, both due to higher base effect, as well as investments made by the company on R&D front, and sales and distribution front. 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. As a result of its current efforts on the R&D and sales/distribution front, its long term prospects are likely to improve.

     

     

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