Q2 comment. Dr. Reddy’s Laboratories: Weak show continues

Pharma major Dr Reddy’s Lab has reported a 3 per cent drop in consolidated net profit to Rs 284 crore in the second quarter of 2017-18 as against Rs 295 crore seen in the same period last year. The fall in the net profit was attributable to the pricing erosion in the US business due to channel consolidation and increasing competition from higher ANDA approvals.

The consolidated total revenue declined marginally by one per cent to ₹ 3,546 crore during the quarter against ₹3,586 crore in the year-ago period.

Business from the global generic, which accounts for 81 per cent of the company’s revenue, declined marginally by one per cent during the quarter on the back of lower contribution from North America which was offset by the better performance in other geographies including Europe and Russia.

Muted US performance

The revenue from North America fell by 4 per cent in the second quarter to Rs 1,432 crore as compared to the same period last year, due to double digit price erosion in the US due to customer consolidation, increased competition and slow realisation from the new launches. The company’s North America business has accounted for 40 per cent of the overall revenue.

The realisation from the recent key launches of generics -Vytorin, Angiomax, and was slow in the second quarter due to immense competition.

Dr Reddy’s US business is likely to be under pressure in the near term due to the impact of further channel consolidation, and competition in key products like Dacogen, Vidaza, Toprol XL and Fondaparinux. Despite the number of key launches including Suboxone, Aloxi, Nuvaring and Copaxone that are lined up for the next 12 months, uncertainty over the regulatory clearance of its key facilities has been the key dampener for its earnings visibility.

The company’s key facilities – Srikakulam, Duvvada and Miryalaguda have been under the US regulatory scanner for few years. Early remediation is important for the company as they continue to weigh on the overall performance. Management has said that the responses to the queries for the Form 483 observation on the Bachupally plant (which accounts for more than half of the US top line drugs) are being addressed while expecting EU’s re-inspection in the fourth quarter for the same. The recent audit conducted by the USFDA on Unit II Formulations Plant in Srikakulum was completed with zero observations. Meanwhile, the API site in Srikakulum is awaiting clearance nod from the US regulator.

During the quarter, the company has launched 4 generics -Sevelamer Carbonate, Cefixime OS, Bupropion XL and Metaxalone. The company has guided for 2-3 new high value launches in the forthcoming quarters.

The management has indicated that it is in process of building strong pipeline of complex products and working on strengthening of quality management system coupled with optimizing the overall cost structure.

Improved Europe and EM sales

The revenue from Russia for the second quarter grew 20 per cent YoY to Rs 3,200 crore driven by higher volume uptake in base business and new launches. The European business reported strong growth on YoY basis (grew by 37 per cent) on the back of new launches and improvement in the base business.

Mediocre India business

The revenue from India grew by 2 per cent YoY to Rs 637 crore during second quarter, with partial recovery in channel restocking post GST implementation. With the higher margin business, the domestic business is expected to see improvement in the subsequent quarters.

Pharmaceutical Services and Active Ingredients (PSAI) business which accounts for 16 per cent of the company’s revenue disappointed as it declined marginally YoY during the quarter.

Operating profit came in at Rs 688 crore for the quarter. The operating margin improved to 19.4 per cent during the quarter from 17.4 per cent seen in the same period last year due to sharp decline in R&D expenses and other expenditure.

R&D expense was at 11.8 per cent of sales in the second quarter against 14.5 per cent of sales in same quarter last year. R&D expense was lower primarily on account of deferment in some of the milestone payout towards the balance part of the year.

At the current price, the stock trades at 36 times its trailing 12-month earnings — around 8 per cent and 30 per cent premium to its peers Sun Pharma and Lupin respectively.