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Dr Reddy's: India disappoints - Views on News from Equitymaster

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Dr Reddy's: India disappoints
Nov 10, 2011

Dr Reddy's has announced its second quarter results for 2012 (2QFY12). The company has reported 21.2% YoY and 7.3% YoY growth in sales and profit after tax respectively. Here is our analysis of the results.

Performance summary
  • Sales grow by 21.2% YoY led by strong growth from North America (NA), Russia & CIS (RCIS) and bulk drugs (PSAI) division. However, there is a slowdown seen in the domestic sales growth.
  • Operating margins (EBITDA) decrease by 50 bps (0.5%) due increase in raw material costs and SG&A expenses.
  • Profit after tax grows by 7.3% YoY due to higher tax outgo

Financial performance: A snapshot
(Rs m) 2QFY11 2QFY12 Change 1HFY11 1HFY12 Change
Net sales 18,704 22,678 21.2% 35,535 42,461 19.5%
Expenditure 14,648 17,863 21.9% 28,067 33,828 20.5%
Operating profit (EBIDTA) 4,056 4,815 18.7% 7,468 8,634 15.6%
EBDITA margin (%) 21.7% 21.2%   21.0% 20.3%  
Other income 219 215 -1.7% 405 402 -0.8%
Depreciation 1,048 1,286 22.7% 2,021 2,502 23.8%
Interest 35 50 41.8% 212 96 -54.8%
Profit before tax 3,192 3,695 15.8% 5,640 6,438 14.1%
Tax 327 630 93.0% 684 750 9.6%
Minority Interest 3 13   8 17  
Profit after tax/(loss) 2,868 3,078 7.3% 4,964 5,705 14.9%
Net profit margin (%) 15.3% 13.6%   14.0% 13.4%  
No. of shares (m) 169 169   169 169  
Diluted earnings per share (Rs) 16.9 18.2   29.3 33.7  
Price to earnings ratio (x)*   23.3        
*Book value as on 30th September 2011

What has driven performance in 2QFY12?
  • Dr Reddy's sales for the quarter grew by a robust 21.2% YoY led by strong performance from Global generics and PSAI division. Global generics, the largest revenue contributor, grew by 18.1% YoY led by robust growth of 42% in North America. The PSAI (bulk drugs) division surprised positively by clocking a growth of 34.4% where growth was driven across geographies. Though the global generics performed well, the domestic formulations saw a growth of around 9.5%, much lower than the industry growth of 13%-14%. A point to note is that it is the fourth consecutive month of muted growth.

    Revenue break-up
    (Rs m) 2QFY11 2QFY12 Change 6mFY11 6mFY12 Change
    PSAI 5,338 7,177 34.4% 10,614 12,938 21.9%
    Global Generics 13,667 16,136 18.1% 25,584 30,560 19.4%
    Proprietary Products 131 264 101.7% 254 461 81.7%
    Others 289 346 19.7% 581 677 16.5%
    Total Sales 19,425 23,922 23.2% 37,033 44,635 20.5%
    Less: Inter-segmental 721 1,244 72.5% 1,498 2,173 45.1%
    Net revenues 18,704 22,678 21.2% 35,535 42,461 19.5%

  • Operating margins (EBITDA) decreased by 50 bps (0.5%) due increase in raw material costs. The huge increase in the SG&A expenses was offset by savings from other expenditure and R&D expenses. The increase in SG&A expenses was partly led by the costs related to the Bristol facility, OTC expenses in Russia and higher staff costs.

  • Dr Reddy's profit after tax increased merely by 7.3% YoY led by higher taxes. From a tax incidence of around 10% in the same quarter previous year, it rose up to 17%.

  • Dr Reddy's introduced 5 new products in the US market, including 2 limited competition products. Fondaparinux, the generic version of Arixtra, currently has a market share of 10% in the US and the company expects it to increase after increasing the production. During the quarter 4 new ANDAs were filed. A total of 76 products (40 para IV and 11 First to File) are pending approval Revenue from the Bristol penicillin facility should ramp up from 3QFY12 and is expected to be around US$ 60 m on an annual basis.

What to expect?
At the current price of Rs 1,617, the stock is trading at a price to earnings multiple of 17 times our estimated FY14 earnings. The management expects the growth to be driven from the North American market. This will be triggered by increasing market share of products like Fondaparinux, Olanzapine and Fexofenadine OTC. The new penicillin facility acquired from GSK will further help. The outlook for the US generics remains buoyant with a strong Para IV pipeline.

In order to capitalize on the blockbuster drugs going off patent over the next few years, the company is focusing on building a strong pipeline in the US. Apart from that the custom manufacturing business and other core businesses will also help on a long-term basis. Having said this, in the medium term, the domestic formulations business is not expected to do well due to factors like high attrition at around 25% and intense pricing pressure from MNCs and local players. Considering all these factors, current valuations do not leave much on the table for investors.

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