Can Dr Reddy's overcome the steep challenges it faces?

Despite assurances, the Indian generics drug major has failed to show any hint of turnaround, however small, from any segment or geography

A near 10% fall in Dr Reddy’s Laboratories Ltd’s share price a day after the company announced disappointing results for the June quarter does not seem out of order as the Indian generics drug major failed to show any hint of turnaround, however small, from any segment or geography.

While in the last quarter of FY16, it was provisioning for a write-off of about $ 60 million revenues from Venezuela that dragged down net profit to as low as Rs 122 crore, the June quarter numbers were dented by US revenues on the back of price erosion and lack of new launches to compensate for the same. Net profit for the quarter stood at Rs 126.3 crore, down 80% from the corresponding period last fiscal.

 

Dr Reddy's management has been blaming multiple headwinds for the poor growth in volumes and profits for the past few quarters, though it has failed to explain why the company has not been able to achieve the promised turnaround in its European business.

The US Food and Drug Administration(US FDA) had issued a warning letter in November 2015 citing three of Dr Reddy's manufacturing facilities. This has impacted the new approvals resulting in few launches in the US market, which contributes close to 60% of the company's global generics business. But the average revenue growth was not quite impressive even prior to this event, as Dr Reddy's seen almost stuck in a range ever since it had crossed the $ 2 billion revenue mark in the year 2012-13.The company revenues stood at $ 2.2 billion in 2013-14, $ 2.4 billion in 2014-15 and $2.3 billion in 2015-16.

In its latest report, Ambit Capital has gone to the extent of saying it is discounting even the management's optimism on presenting the US FDA acting as a key catalyst for clearing its facilities: "Presenting to the US FDA has not guaranteed any positive result in the past for other companies. We remain cautious as issues raised in the warning letter are serious and are strongly worded." 

An FDA all-clear is the only hope Dr Reddy's has to possibly reverse the downslide as other issues such as stoppage of business in Venezuela, the slide in the rouble’s value, and erosion of value of its top assets in the US continue to put pressure on earnings.
 
The other initiatives of Dr Reddy's remain largely long-term as Ambit maintains that the fruits of a decade-long capital allocation towards innovative R&D for developed markets(versus peers' generics focus) will remain elusive given expensive clinical trials, high risk of failure, and lack of a track record.

Citing the first quarter results, Kotak Institutional Equities said its worries turned into reality. “Dr Reddy's reported a very poor set of 1QFY17 numbers with an across-the-board-miss," it said on Wednesday.
US revenues declined by $ 54 million quarter-on-quarter and all other divisions missed estimates; high operating leverage meant that the US decline had a direct impact on EBITDA, which was further exacerbated by $ 16 million FDA remediation costs, according to the report.

The sharp erosion in US sales was a consequence of several factors including competitive pressures in Valcyte and Vidaza, share loss in OTC products, particularly, Omeprazole, double-digit pricing pressure in the base business among other things, according to Kotak.