GST, pricing pressure in US lead to dismal show for Dr Reddy's in Q1

With GST led destocking behind, next few quarters may see some improvement

Dr Reddy’s performance for the quarter ending June came much lower than expectations on all fronts. While the US business continues to see pricing pressure, the India business is seeing the impact of GST-led destocking, which has added to the company's woes. US generic sales, contributing 45 per cent to total revenues, declined four per cent year-on-year (y-o-y) while India formulations sales, contributing 14 per cent, declined by a sharp ten per cent. Though Europe generic sales, contributing about six per cent to total revenues, and emerging markets generic sales (17 per cent) did grow 28 and 34 per cent, respectively, providing some respite, they were not enough to drive revenues to meet Street expectations.

At Rs 3,316 crore, total sales (up three per cent y-o-y, down 6.7 per cent sequentially) came lower than Bloomberg consensus estimates of Rs 3,443 crore.
 

The disappointment was more profound at the operating level. The declining US revenues and increasing competition were bound to impact margins. The company said that US revenues declined led by higher price erosion and increased competition in its key products — valgancyclovir (anti-viral) and oncology drugs Decitabine, Azacitadine, etc, which was partly offset by the launch of four new products. Also, since India revenues suffered, margin impact was bound to be higher.

Rising selling and general expenses, research and development costs, and other expenses added further to margin pressure. At 10.1 per cent, the Ebitda (earnings before interest, taxes, depreciation and amortisation) margins came 240 basis point lower y-o-y and about 760 basis points sequentially, which was a big disappointment. With 17.7 per cent Ebitda margins in the March quarter, the Street was not expecting such a sharp decline. At Rs 336 crore, Ebitda, thus, was nearly half the Rs 644 crore figure indicated by consensus estimates. At Rs 59 crore, net profit, too, was way lower than the Rs 297 crore figure indicated by consensus estimates.

With this performance, the stock closed 3.29 per cent lower at Rs 2,621.45 levels.

While the first quarter performance may have disappointed, the performance in subsequent quarters may improve with GST-led destocking being left behind. Also, analysts, like Ranvir Singh at Systematix Stock Broking, point out that the recent data indicate that competitive intensity in the US is not increasing further. However, while the company is taking measures to cut costs in a bid to improve profitability, for a significant improvement in overall performance, it needs to be out from under the US Food and Drug Administration's (USFDA's) scanner by getting its three plants cleared. This is not only necessary for revenue growth but margin improvement too. Not only competitive pressure but, at times, sourcing ingredients from outside impacts margins as major active pharmaceutical ingredient plants in India remain under USFDA scanner, say analysts. Thus, in the near term, the stock price may also remain range-bound.

Though the company has not given any guidance for any timeline, analysts feel that resolution should come in FY18 and, hence, see an earnings upside from FY19. Singh says that he will maintain his forward estimates, expecting a resolution in the next three quarters.

Analysts at HDFC Securities say that they continue to have a Neutral rating on the stock as they believe the pain in the US market is likely to continue for two-three quarters with no visibility on Duvvada resolution. The only key trigger in the near term would be the management's commentary on the Copaxone launch.