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Dr. Reddy’s: The best of the lot?

Oct 28, 2006

Performance summary
Dr. Reddy’s has announced very strong results for the second quarter and half year ended September 2006. The superlative topline growth has been attributed to revenues from acquisitions, authorised generics revenues from ‘Proscar’ and ‘Zocor’, and growth in its core businesses. Operating margins have considerably expanded on the back of reduction in almost all costs (as a percentage of sales) excluding raw material costs. All these factors have contributed to the impressive growth in bottomline despite the surge in interest costs.

Consolidated numbers
(Rs m) 2QFY06 2QFY07 Change 1HFY06 1HFY07 Change
Net sales 5,611 19,440 246.5% 10,995 32,807 198.4%
License fees and service income 30 196 556.9% 43 320 639.0%
Expenditure 4,504 14,754 227.6% 9,256 25,725 177.9%
Operating profit (EBDITA) 1,137 4,882 329.4% 1,782 7,402 315.4%
EBDITA margin (%) 20.3% 25.1%   16.2% 22.6%  
Other income 206 190 -7.9% 445 436 -2.2%
Interest (net) 46 474 927.3% 81 862 963.0%
Depreciation 354 827 133.4% 702 1,675 138.7%
Profit before tax 943 3,771 300.0% 1,444 5,300 267.0%
Tax 35 850 2315.3% 230 1,090 374.7%
Minority interest 1 4   1 4 207.7%
Profit after tax/(loss) 909 2,925 221.7% 1,216 4,214 246.6%
Net profit margin (%) 16.2% 15.0%   11.1% 12.8%  
No. of shares (m) 76.7 153.4   76.7 153.4  
Diluted earnings per share (Rs)*         29.1  
Price to earnings ratio (x)*         25.1  
(* on a trailing 12-months basis)

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 was the first from India to get an Exclusive Marketing Right (EMR) in the US market for Fluoxetine Axetil. Active Pharmaceutical ingredients (API's) constituted 39% of the company's business, while formulations contributed 44% to revenues in FY06. The generics business in regulated markets formed 10% of total revenues. The rest came from custom pharmaceutical services and critical care and biotechnology businesses. In 2005, the company formed India’s first integrated drug research company Perlecan Pharma for the purpose of conducting clinical trials on its NCE assets.

What has driven performance in 2QFY07?
US and Europe drive topline: The robust 247% YoY growth in topline was a result of good growth across all its businesses namely, APIs, generics, domestic and international formulations and custom manufacturing. The API segment witnessed a 36% YoY growth on a consolidated basis led by growth in Europe (driven by ‘sertraline’ and ‘ramipril’) and rest of the world markets. However, revenues from North America and India registered a decline in revenues.

The generics business witnessed a strong growth during the quarter with contribution from both the US and Europe. In the US, growth was primarily driven by the launch of ‘Fexofenadine’ (Allegra), which saw limited competition even after the lapse of the 180-day exclusivity awarded to US-based Barr Laboratories. This product generated revenues to the tune of Rs 807 m (4% of total sales) during the quarter. Besides this, the authorised generics deal that Dr. Reddy’s had signed with the innovator Merck for two of its products – ‘Finastride’ (Proscar) and ‘Simvastatin’ (Zocor) also played a significant role in propelling revenues. Since the 180-day exclusivity was granted to Teva (for Proscar) and Teva and Ranbaxy (for Zocor), Dr. Reddy’s was also able to benefit from this exclusivity period. Revenues from these authorised generics contributed 40% to revenues in 2QFY07.

In Europe, revenue growth from generics was driven by contribution from Betapharm (the German company acquired in February 2006). Betapharm contributed 13% to total sales during the quarter. After the regulatory changes introduced by the German government, while pricing pressure continued, Betapharm was able to record growth in volumes. That said, if one were to exclude Betapharm’s revenues, then revenue growth from the European region actually was flat. This was due to decline in prices of its key products – ‘amlodipine’ and ‘omeprazole’ in the UK.

Standalone business snapshot
(Rs m) 2QFY06 2QFY07 Change 1HFY06 1HFY07 Change
APIs and Intermediates 2,161 3,119 44.4% 4,185 5,638 34.7%
PBIT margin (%) 15.7% 19.0%   11.6% 16.1%  
Formulations 2,479 3,284 32.5% 5,085 6,389 25.6%
PBIT margin (%) 35.3% 36.5%   38.5% 38.2%  
Generics 696 2,579 270.4% 1,341 3,851 187.1%
PBIT margin (%) 24.1% 69.3%   12.1% 57.3%  
Critical Care and Biotechnology 173 214 23.5% 299 384 28.3%
PBIT margin (%) 38.4% 11.1%   15.4% -1.5%  
Custom Pharmaceuticals Services 83 793 853.5% 120 1,909 1490.9%
PBIT margin (%) 21.9% 12.4%   -12.1% 11.7%  
Drug discovery 1 37   1 63 5125.0%
Total gross revenues 5,593 10,026 79.3% 11,032 18,232 65.3%

In the formulations segment, international sales grew by 23% YoY on a consolidated basis driven by the performance of Russia and CIS markets. While revenues from Russia grew by 18% YoY, revenues in the CIS markets registered a 11% YoY growth. Domestic formulations revenues grew by 16% YoY in line with the industry growth rate driven by its key brands ‘Omez’, ‘Nise’ and ‘Reclimet’. Revenues from the custom manufacturing business witnessed significant traction due to the revenues from the acquisition of Roche’s manufacturing facility in Mexico. Excluding this acquisition, revenues from this business grew by a strong 92% YoY due to growth in its customer base and product portfolio.

Sharp margin expansion: Margins expanded by 480 basis points during the quarter, largely driven by a steep fall in R&D expenditure and other expenditure (as a percentage of sales). Raw material costs, however, witnessed a considerable rise due to increase in contribution from authorised generics. It must be noted that authorised generic players cannot manufacture the generic product ton their own but instead have to purchase the same from the innovator company, thereby leading to a rise in raw material costs. The fall in R&D expenditure was on the back of benefits from its R&D partnership with ICICI Venture for reimbursement of expenses incurred for the filing of ANDAs in the US and also for reimbursement of expenses from Perlecan Pharma for its NCE research.

Cost break-up (Consolidated)
(as % of sales) 2QFY06 2QFY07 1HFY06 1HFY07
Raw material 33.3% 49.0% 33.8% 46.7%
Staff cost 13.6% 8.1% 13.7% 9.5%
R&D expenses 6.3% 2.2% 7.1% 2.9%
Selling expenses 11.2% 6.9% 11.1% 8.0%
Other expenditure 15.9% 9.7% 18.4% 11.3%

Bottomline bloats: A strong topline growth and operating margin improvement contributed to the superlative bottomline growth despite a sharp rise in interest costs. It must be noted that Dr. Reddy’s had obtained a long-term loan for funding the acquisition of Betapharm, which had led to higher interest charges.

Quarterly trend
(%) 2QFY06 3QFY06 4QFY06 1QFY07 2QFY07
Net sales growth 7.0% 26.5% 71.2% 148.4% 246.5%
Operating profit margin 20.3% 12.5% 7.7% 18.9% 25.1%
Net profit margin 16.2% 11.4% -5.6% 9.6% 15.0%

What to expect?
At the current price of Rs 730, the stock is trading at a price to earnings multiple of 17.7 times our estimated FY09 earnings. Going forward, while the launches of ‘Simvastatin’ and ‘Finasteride’ in the US market will drive growth in FY07, a stronger product flow in the US, growth in Betapharm and the custom manufacturing business will be long-term drivers. The custom manufacturing business is expected to scale up going forward with the acquisition of Roche’s manufacturing facility in Mexico. As regards Betapharm, while the company is likely to face pricing pressure in the medium term due to regulatory changes in the German market, in the long-term Betapharm is expected to boost Dr.Reddy’s presence in the European region. 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. Given Dr.Reddy’s superlative performance in 1HFY07, we shall have to accordingly revise our estimates for the full year.

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Aug 7, 2020 (Close)


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