Dr Reddy's lower margins disappoint Street

While the US and emerging market are doing well on new product introductions, higher costs & segment mix lead to lower margins

Dr Reddy's Laboratories lost 2.6 per cent on the bourses, closing at Rs 2,026.30 after the company's March quarter numbers, especially on the margins front, were lower than expectations.

While revenues grew a steady 26 per cent, gross margins at 50.43 per cent were 212 basis points lower than the 52.55 per cent reported in the year-ago quarter. Higher other income, as well as interest income, boosted operating margins and net profit.

The other operating income was boosted by a $22.5-million cash payment from Nordion Inc towards settlement of a court case. Thus, operating margins came in at 22.2 per cent.

If the gains are adjusted, analysts believe margins would have been at 17-20 per cent, lower than the number in the March 2012 quarter of 25.5 per cent. However, for the year, gross margins at 52 per cent are in line, observes Sarabjit Kaur Nangra, vice-president research at Angel Broking.

On the positive side, the company saw strong growth in the pharmaceutical services and the active ingredients (PSAI) segment.

The segment revenues in the year grew 29 per cent over FY12, while during the quarter, growth was at a robust 25.44 per cent year-on-year (y-o-y) (34 per cent sequentially). This is being looked at positively by analysts, though the segment enjoys lower margins (32 per cent compared to 59 per cent in global generics).

New launches
The North American revenues grew 19 per cent y-o-y in FY13. However, the higher number of product approvals seen during the second half and thereby increase in launches helped the US revenues grow 26 per cent in the March 2013 quarter.

Products, such as the anti-hypertensive drug Toprol-XL, launched in the US during September 2012, gained good traction and is likely to have contributed $21 million to US revenues during the March 2013 quarter. Propecia, the product launched on exclusivity in February 2013, used for treating hair fall, is likely to have contributed $12 million in just two months, according to Emkay estimates.

 

The traction in the US revenues is likely to continue with more products launched towards the end of the March 2013 quarter. An osteoporosis treatment product, Zumeta, had been launched towards the end of March, anticipated to become a $10-15 million product for Dr Reddy's according to Morgan Stanley estimates, besides osteoporosis injectibles, as well as an acne treatment product.

Looking at the product launches and approvals picking up, analysts at Citi in their March report had observed that Dr Reddy's performance in FY14 is likely to gain from the spillover of approvals from FY13.

They add that they expect Dr Reddy's to launch several key injectibles over the next 12-36 months, revenues from which was likely to be bulky rather than even across quarters. Analysts at Morgan Stanley see steady earnings momentum of 15 per cent annually over FY13-15.

Emerging markets steady
The company is doing well in the emerging markets, of strategic importance now. Russian revenues grew 28 per cent during the quarter. However, the company has not been able to impress on the domestic front. The fourth quarter domestic growth at nine per cent just matched the pharma market growth while lagging peers, such as Lupin.

Though, generally, analysts remain positive on the company, they are looking for some first-to-file opportunities to provide triggers.

Ranjit Kapadia at Centrum said he remains positive on the stock, looking at good growth in the PSAI segment, as well as the US markets and some new approvals for launches on exclusivity. Products such as Vidaza, Dacogen and a couple of niche opportunities are some of the pending approvals over the next few months, which can accelerate US growth. However, Hitesh Mahida at Fortune says delay in approval of products as Vidaza ($60-70 million estimated revenues) could disappoint.

Overall, looking at the consensus target price of Rs 2,100, according to Bloomberg data, the stock seems to be having limited upside in the near term factoring in benefits of recent US launches and awaiting new triggers. The management has not made a forecast on revenue, looking at the delays in product launches last year.