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DR.REDDYS LABORATORIES
Slower ramp-up in US sales impacts operating performance
Operating performance lagged expectations
Dr Reddy’s Laboratories’ (DRRD) Q3FY11 adjusted PAT of INR 3.1 bn (29%
Y-o-Y) was below our estimate of INR 3.87 bn, led by lower than expected sales
in new launches and charge back on account of Lotrel (~USD5 mn impact). Net
sales of INR 18.9 bn (10% Y-o-Y), was impacted from poor performance at
Betapharma, PSAI as well as Russia (4% growth vs. est. of 20%) and lowerthan-
expected contribution from new products. Operating profit margin of 15.5%
was flat Y-o-Y and had impact from one-time fixed costs (USD 9 mn because of
litigation expenses for Allegra-D, one time cost on debt refinancing and higher
promotion expenditures on OTC products in Russia). Adj. for these operating
margins was 17.6% (up 26% Y-o-Y) driven by higher realization in niche
products.
Charge back & lower off-take impacted US performance
US generics business growth of 8% Q-o-Q to INR 4.76 bn has been below our
estimate of INR 5.3 bn, largely from slower than expected contribution from new
launches in US (USD 5 mn vs. est. of USD 17-18mn). Moreover, incremental
market share gain from Tacrolimus (launched in Q1 FY11) and Omeprazole OTC
was offset by price erosion in generic Lotrel (estimated 4-5 mn impact). Europe
declined by 18% Y-o-Y (versus -12% estimated), while Russia & CIS sales (4%
Y-o-Y) had negative impact from higher base in Q3 FY10. PSAI sales growth
remains sluggish (-4% Y-o-Y) with small signs of pick-up in order volumes.
Gaining traction in limited competition products; Execution is the key
Consolidation in existing products and new product launches is expected to drive
DRL’s US revenues going forward. Some of its limited competition products such
as Omeprazole & Tacrolimus have already started gaining traction in the last few
months. We expect generic Prevacid to gain market share as the initial channel
dumping by the competitors has already been exhausted. While we believe that
DRRD has built up robust pipeline of niche and limited competition products in
US market, successful execution of the same will drive future valuations.
Outlook and valuations: Maintain core earnings
Owing to strong growth visibility in branded generic business, improved traction
in limited competition products and potential upside from GSK deal, we maintain
our core earnings estimate of INR 78 for FY12 and introduce FY13 EPS of INR 87.
Our SOTP based TP for DRRD is INR 1736, valuing base business at 21x FY12
core earnings and INR 94 per share for NPV of Para IV. Stock has corrected 10%
in last month and we believe that any future correction could be a good buying
opportunity. We maintain “HOLD/Sector Outperformer” rating.
Operating performance lagged expectations
DRRD’s operating performance was below our estimates, as lower sales growth and onetime
costs (USD 9 mn) offset higher gross margins from exclusive launches in the US.
Net revenue, at INR 18.9 bn, grew 10% Y-o-Y and was lower than our estimate of INR
20.6 bn. The sale miss was primarily due to lower-than-expected ramp-up from new
products launched in US and charge back on account of price erosion in generic Lotrel
(INR 4.7 bn; 60% Y-o-Y). Moreover, Russia and PSAI also depicted slower growth of 4%
Y-o-Y and -4% Y-o-Y, respectively, impacting operating performance.
Gross margins at ~55% (versus our estimate of 54% and 53% in Q2FY11), benefited
from better product mix due to higher contribution of semi-exclusive products like
tarcolimus, Omeprazole OTC and improved market share of fexofenadine & ciprofloxacin
where the realizations are high. Gross margins in global generics business and PSAI were
at 65% and 28%, respectively. PSAI gross margins improved Q-o-Q (from 22% in Q2
FY11) with positive operating leverage from higher growth in APIs segment, led by
increased product launches, as per the company.
Adjusted operating profit of INR 3.45 bn was lower than our estimate of INR 4.5 bn, due
to lower sales and higher R&D and S,G&A expenses partly offset by better-than-expected
gross margins. Fixed costs increased 24% Y-o-Y to INR 7.3 bn (versus our estimate of
INR 6.5 bn), primarily from one time costs of USD 9 mn led by litigation expenses for
Allegra-D-24, debt refinancing at Betapharma and one time promotional cost on OTC
portfolio in Russia. Further, R&D expenses increased by 46% Y-o-Y (~7% of sales) led
by higher scale in R&D activities from generics, biologics and proprietary products
development. DRRD expects to launch fourth biosimilar in domestic market by Q4FY11.
Operating margins at 17.6% (adjusted for one time costs), versus 15.4% in Q3FY10,
was lower than our estimate of 21.9%.
Adjusted net profit of INR 3.05 bn (excluding INR 45 mn forex gain and USD 9 mn fixed
costs, up 28% Y-o-Y) was 20% below our estimate of INR 3.8 bn. Tax rate of 5% versus
estimated 13%. Lower tax rate reflects the benefit of higher weighted average deduction
of R&D expense. The company has guided for 11-12% tax rate for FY11.
Charge back and lower off-take impacted US performance
US generics sales of INR 4.76 bn (versus our estimate of INR 5.3 bn) was impacted from
slower ramp-up from new product launches in US and price erosion in generic Lotrel.
During the quarter, DRRD has launched two limited competition products, generic
Prevacid (USD 600mn market size; 3 generic players) and generic Accolate (USD 50mn
market size; 180 days exclusivity; 2 generic players). Contribution from these two
products was lower than our expectations (USD4-5mn versus our estimate of USD14-
15mn), mainly because of a) channel filling in generic Prevacid by other generic players,
and b) Surprise entry of authorised generic in Accolate. Moreover, incremental market
share gain from Tacrolimus (launched in Q1 FY11) and other products was offset by price
erosion in generic Lotrel (estimated chargeback of ~4-5 mn). Management is also
confident to launch g Allegra-D-24 and generic Arixtra in next couple of months in the
US market. Going forward, we expect DRRD to gain decent market share in generic
Prevacid (USD7-8mn revenue in Q4FY11) as the inventory pumped up by the
competitors in the trade has already been exhausted.
Branded business outlook remain positive; Betapharm and PSAI continue to
drag performance
Domestic formulations growth of 14% Y-o-Y was rather slow (than 25% Y-o-Y in Q2
FY11). The growth was driven by volume growth of 8% (lower than 16% in Q2 FY11)
and new product introduction led growth of 6%. The company has launched 16 new
products and introduced three biosimilars during FY11. DRRD expect to launch fourth
biosimilar by Q4 FY11. Management expects increase in field force coverage (400 FF)
and new product introductions to sustain future growth momentum and guides for 18-
20% growth for FY11E. We have estimated domestic business to grow 17% Y-o-Y in
FY11E
Russia & CIS sales grew 4% Y-o-Y to INR 2.87 bn and had negative impact from higher
base in Q3 FY10. Russia continued to depict strong secondary sales growth of 21%
versus industry growth of 8% Y-o-Y. DRRD expects to ramp-up sales in Russia
significantly by aggressively launching OTC products (in licensed through Cipla tie-up).
Europe declined by 18% Y-o-Y (versus -12% estimated), due to sharp decline in
Betapharm sales (-33% Y-o-Y). Ex- Betapharm, Europe growth has been impressive at
40% Y-o-Y. Betapharm has been negatively impacted by pricing pressures in tender
business. Lower than anticipated tender (three products in recent AOK tenders) has led
to further decline in volume growth. Although revenue growth in Betapharm remain
challenging, management has reduced fixed overheads from cost rationalization, leading
to positive operating profits.
PSAI sales growth continue to remain slow and declined 4% Y-o-Y, to INR 4.9 bn, 6%
lower than estimated INR 5.2 bn, primarily due weak demand for services. However, API
sales have picked up on the back of new product launches. The company has filed 9
DMFs during the quarter with cumulative DMF filings at 436 (versus 390 in Q2 FY11).
Gaining traction in limited competition products; execution key to stock
performance
Consolidation in existing products as well as new product launches is expected to drive
DRRD US revenue growth (USD 350 mn in FY10 and USD 1 bn in FY13E). Few of its
limited competition products such as Omeprazole OTC and Tacrolimus have already
started gaining traction in the last few months. We expect generic Prevacid to gain
market share as the initial channel dumping by the competitors has already been
exhausted. Moreover, other niche product launches such as Allegra D 24 (USD 200mn
market size), Fondaparinux (USD 300mn market size) and Propecia (USD 120mn market
size) will further aid the earning momentum. While we believe that DRRD has built up
robust pipeline of niche and limited competition products in the US, successful execution
of the same will drive mid-term growth and valuations.
Outlook and Valuations: Maintain core earnings estimate and Hold rating
Owing to strong growth visibility in branded generic business, improved traction in
limited competition products and potential upside from GSK deal, we maintain our core
earnings estimate of INR 78 for FY12 and introduce FY13 EPS of INR 87. Although DRRD
has robust pipeline of niche products in US, however, successful execution of the same
remains the key for mid-term growth and valuations of the company. Our SOTP based
fair value for DRRD is INR 1736 per share, valuing base business at 21x FY12 core
earnings and INR 94 per share for NPV of Para IV. Stock has corrected more than 10% in
last one month and we believe that any future correction could be a buying opportunity.
At CMP of INR 1560, the stock is trading at 20x FY12 core earnings. We maintain
“HOLD/Sector Outperformer” rating on the stock.
Company Description
Promoted by Dr. K Anji Reddy, a first generation entrepreneur, DRRD is a professionally
managed company with revenues of USD 1.6 bn in FY10 (30% CAGR between FY06 and
FY10). Operating in 40 plus countries, international operations revenue contribution has
increased to 82% currently from 40% in FY00, with US/Russia operations contributing
c.32% of FY10 sales. DRRD has set itself an internal target of USD 3 bn revenues and
ROCE of 25% by FY13. A key strength for the company has been its vertical integration
through its Pharmaceutical Services & Active Ingredients (PSAI) operations and 16
manufacturing bases (10 USDFDA approved) which allow DRRD to have one of the best
gross margin ratios in the Indian pharmaceutical industry. This is actively supported by
an extensive R&D program, which spans CRAMs to drug discovery. It also has one of the
deepest pipelines of bio-similars amongst leading global generic companies, addressing
global brand sales of USD 30 bn.
Investment Theme
DRRD’s base business is expected to grow at 13% CAGR in FY10-13E, on back of
branded formulations sales CAGR of 19%. Domestic formulation growth is expected to
post ~17-18% CAGR with robust product introductions and increased geographical
expansion, while Russian operations are expected to post 17% CAGR in FY10-13E. US
revenues are expected to grow at 24% CAGR to INR 23 bn in FY12E and will likely
benefit from “one-off” opportunities in omeprazole OTC, lansoprazole, fondaparinux and
Allegra 24D.
Key risks
Rupee appreciation: Rapid rupee appreciation could impact our sales estimate,
especially on international revenues which are currently based on a currency estimate of
USD/INR of INR 46 for estimates.
Implementation of GST could impact domestic business: The targeted
implementation of the unified GST code by the government could impact the company’s
domestic formulation business (20% of FY10 sales). Historical precedents as seen in the
implementation of VAT in 2005 suggest that there could be temporary disruption in sales
around the time of implementation of the new tax code, as the distribution channel takes
time to absorb the new changes and until clarity on issues like tax rates on inventory
levels emerge. Moreover, this could get exacerbated, if there is a partial state by state
rollout of GST, rather than a national roll out, as is currently envisaged.
Regulatory issues: Regulatory issues including product approval delays, unfavorable
litigation outcomes and potential future adverse inspections from USFDA are structural
negatives for DRRD.
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
DR.REDDYS LABORATORIES
Slower ramp-up in US sales impacts operating performance
Operating performance lagged expectations
Dr Reddy’s Laboratories’ (DRRD) Q3FY11 adjusted PAT of INR 3.1 bn (29%
Y-o-Y) was below our estimate of INR 3.87 bn, led by lower than expected sales
in new launches and charge back on account of Lotrel (~USD5 mn impact). Net
sales of INR 18.9 bn (10% Y-o-Y), was impacted from poor performance at
Betapharma, PSAI as well as Russia (4% growth vs. est. of 20%) and lowerthan-
expected contribution from new products. Operating profit margin of 15.5%
was flat Y-o-Y and had impact from one-time fixed costs (USD 9 mn because of
litigation expenses for Allegra-D, one time cost on debt refinancing and higher
promotion expenditures on OTC products in Russia). Adj. for these operating
margins was 17.6% (up 26% Y-o-Y) driven by higher realization in niche
products.
Charge back & lower off-take impacted US performance
US generics business growth of 8% Q-o-Q to INR 4.76 bn has been below our
estimate of INR 5.3 bn, largely from slower than expected contribution from new
launches in US (USD 5 mn vs. est. of USD 17-18mn). Moreover, incremental
market share gain from Tacrolimus (launched in Q1 FY11) and Omeprazole OTC
was offset by price erosion in generic Lotrel (estimated 4-5 mn impact). Europe
declined by 18% Y-o-Y (versus -12% estimated), while Russia & CIS sales (4%
Y-o-Y) had negative impact from higher base in Q3 FY10. PSAI sales growth
remains sluggish (-4% Y-o-Y) with small signs of pick-up in order volumes.
Gaining traction in limited competition products; Execution is the key
Consolidation in existing products and new product launches is expected to drive
DRL’s US revenues going forward. Some of its limited competition products such
as Omeprazole & Tacrolimus have already started gaining traction in the last few
months. We expect generic Prevacid to gain market share as the initial channel
dumping by the competitors has already been exhausted. While we believe that
DRRD has built up robust pipeline of niche and limited competition products in
US market, successful execution of the same will drive future valuations.
Outlook and valuations: Maintain core earnings
Owing to strong growth visibility in branded generic business, improved traction
in limited competition products and potential upside from GSK deal, we maintain
our core earnings estimate of INR 78 for FY12 and introduce FY13 EPS of INR 87.
Our SOTP based TP for DRRD is INR 1736, valuing base business at 21x FY12
core earnings and INR 94 per share for NPV of Para IV. Stock has corrected 10%
in last month and we believe that any future correction could be a good buying
opportunity. We maintain “HOLD/Sector Outperformer” rating.
Operating performance lagged expectations
DRRD’s operating performance was below our estimates, as lower sales growth and onetime
costs (USD 9 mn) offset higher gross margins from exclusive launches in the US.
Net revenue, at INR 18.9 bn, grew 10% Y-o-Y and was lower than our estimate of INR
20.6 bn. The sale miss was primarily due to lower-than-expected ramp-up from new
products launched in US and charge back on account of price erosion in generic Lotrel
(INR 4.7 bn; 60% Y-o-Y). Moreover, Russia and PSAI also depicted slower growth of 4%
Y-o-Y and -4% Y-o-Y, respectively, impacting operating performance.
Gross margins at ~55% (versus our estimate of 54% and 53% in Q2FY11), benefited
from better product mix due to higher contribution of semi-exclusive products like
tarcolimus, Omeprazole OTC and improved market share of fexofenadine & ciprofloxacin
where the realizations are high. Gross margins in global generics business and PSAI were
at 65% and 28%, respectively. PSAI gross margins improved Q-o-Q (from 22% in Q2
FY11) with positive operating leverage from higher growth in APIs segment, led by
increased product launches, as per the company.
Adjusted operating profit of INR 3.45 bn was lower than our estimate of INR 4.5 bn, due
to lower sales and higher R&D and S,G&A expenses partly offset by better-than-expected
gross margins. Fixed costs increased 24% Y-o-Y to INR 7.3 bn (versus our estimate of
INR 6.5 bn), primarily from one time costs of USD 9 mn led by litigation expenses for
Allegra-D-24, debt refinancing at Betapharma and one time promotional cost on OTC
portfolio in Russia. Further, R&D expenses increased by 46% Y-o-Y (~7% of sales) led
by higher scale in R&D activities from generics, biologics and proprietary products
development. DRRD expects to launch fourth biosimilar in domestic market by Q4FY11.
Operating margins at 17.6% (adjusted for one time costs), versus 15.4% in Q3FY10,
was lower than our estimate of 21.9%.
Adjusted net profit of INR 3.05 bn (excluding INR 45 mn forex gain and USD 9 mn fixed
costs, up 28% Y-o-Y) was 20% below our estimate of INR 3.8 bn. Tax rate of 5% versus
estimated 13%. Lower tax rate reflects the benefit of higher weighted average deduction
of R&D expense. The company has guided for 11-12% tax rate for FY11.
Charge back and lower off-take impacted US performance
US generics sales of INR 4.76 bn (versus our estimate of INR 5.3 bn) was impacted from
slower ramp-up from new product launches in US and price erosion in generic Lotrel.
During the quarter, DRRD has launched two limited competition products, generic
Prevacid (USD 600mn market size; 3 generic players) and generic Accolate (USD 50mn
market size; 180 days exclusivity; 2 generic players). Contribution from these two
products was lower than our expectations (USD4-5mn versus our estimate of USD14-
15mn), mainly because of a) channel filling in generic Prevacid by other generic players,
and b) Surprise entry of authorised generic in Accolate. Moreover, incremental market
share gain from Tacrolimus (launched in Q1 FY11) and other products was offset by price
erosion in generic Lotrel (estimated chargeback of ~4-5 mn). Management is also
confident to launch g Allegra-D-24 and generic Arixtra in next couple of months in the
US market. Going forward, we expect DRRD to gain decent market share in generic
Prevacid (USD7-8mn revenue in Q4FY11) as the inventory pumped up by the
competitors in the trade has already been exhausted.
Branded business outlook remain positive; Betapharm and PSAI continue to
drag performance
Domestic formulations growth of 14% Y-o-Y was rather slow (than 25% Y-o-Y in Q2
FY11). The growth was driven by volume growth of 8% (lower than 16% in Q2 FY11)
and new product introduction led growth of 6%. The company has launched 16 new
products and introduced three biosimilars during FY11. DRRD expect to launch fourth
biosimilar by Q4 FY11. Management expects increase in field force coverage (400 FF)
and new product introductions to sustain future growth momentum and guides for 18-
20% growth for FY11E. We have estimated domestic business to grow 17% Y-o-Y in
FY11E
Russia & CIS sales grew 4% Y-o-Y to INR 2.87 bn and had negative impact from higher
base in Q3 FY10. Russia continued to depict strong secondary sales growth of 21%
versus industry growth of 8% Y-o-Y. DRRD expects to ramp-up sales in Russia
significantly by aggressively launching OTC products (in licensed through Cipla tie-up).
Europe declined by 18% Y-o-Y (versus -12% estimated), due to sharp decline in
Betapharm sales (-33% Y-o-Y). Ex- Betapharm, Europe growth has been impressive at
40% Y-o-Y. Betapharm has been negatively impacted by pricing pressures in tender
business. Lower than anticipated tender (three products in recent AOK tenders) has led
to further decline in volume growth. Although revenue growth in Betapharm remain
challenging, management has reduced fixed overheads from cost rationalization, leading
to positive operating profits.
PSAI sales growth continue to remain slow and declined 4% Y-o-Y, to INR 4.9 bn, 6%
lower than estimated INR 5.2 bn, primarily due weak demand for services. However, API
sales have picked up on the back of new product launches. The company has filed 9
DMFs during the quarter with cumulative DMF filings at 436 (versus 390 in Q2 FY11).
Gaining traction in limited competition products; execution key to stock
performance
Consolidation in existing products as well as new product launches is expected to drive
DRRD US revenue growth (USD 350 mn in FY10 and USD 1 bn in FY13E). Few of its
limited competition products such as Omeprazole OTC and Tacrolimus have already
started gaining traction in the last few months. We expect generic Prevacid to gain
market share as the initial channel dumping by the competitors has already been
exhausted. Moreover, other niche product launches such as Allegra D 24 (USD 200mn
market size), Fondaparinux (USD 300mn market size) and Propecia (USD 120mn market
size) will further aid the earning momentum. While we believe that DRRD has built up
robust pipeline of niche and limited competition products in the US, successful execution
of the same will drive mid-term growth and valuations.
Outlook and Valuations: Maintain core earnings estimate and Hold rating
Owing to strong growth visibility in branded generic business, improved traction in
limited competition products and potential upside from GSK deal, we maintain our core
earnings estimate of INR 78 for FY12 and introduce FY13 EPS of INR 87. Although DRRD
has robust pipeline of niche products in US, however, successful execution of the same
remains the key for mid-term growth and valuations of the company. Our SOTP based
fair value for DRRD is INR 1736 per share, valuing base business at 21x FY12 core
earnings and INR 94 per share for NPV of Para IV. Stock has corrected more than 10% in
last one month and we believe that any future correction could be a buying opportunity.
At CMP of INR 1560, the stock is trading at 20x FY12 core earnings. We maintain
“HOLD/Sector Outperformer” rating on the stock.
Company Description
Promoted by Dr. K Anji Reddy, a first generation entrepreneur, DRRD is a professionally
managed company with revenues of USD 1.6 bn in FY10 (30% CAGR between FY06 and
FY10). Operating in 40 plus countries, international operations revenue contribution has
increased to 82% currently from 40% in FY00, with US/Russia operations contributing
c.32% of FY10 sales. DRRD has set itself an internal target of USD 3 bn revenues and
ROCE of 25% by FY13. A key strength for the company has been its vertical integration
through its Pharmaceutical Services & Active Ingredients (PSAI) operations and 16
manufacturing bases (10 USDFDA approved) which allow DRRD to have one of the best
gross margin ratios in the Indian pharmaceutical industry. This is actively supported by
an extensive R&D program, which spans CRAMs to drug discovery. It also has one of the
deepest pipelines of bio-similars amongst leading global generic companies, addressing
global brand sales of USD 30 bn.
Investment Theme
DRRD’s base business is expected to grow at 13% CAGR in FY10-13E, on back of
branded formulations sales CAGR of 19%. Domestic formulation growth is expected to
post ~17-18% CAGR with robust product introductions and increased geographical
expansion, while Russian operations are expected to post 17% CAGR in FY10-13E. US
revenues are expected to grow at 24% CAGR to INR 23 bn in FY12E and will likely
benefit from “one-off” opportunities in omeprazole OTC, lansoprazole, fondaparinux and
Allegra 24D.
Key risks
Rupee appreciation: Rapid rupee appreciation could impact our sales estimate,
especially on international revenues which are currently based on a currency estimate of
USD/INR of INR 46 for estimates.
Implementation of GST could impact domestic business: The targeted
implementation of the unified GST code by the government could impact the company’s
domestic formulation business (20% of FY10 sales). Historical precedents as seen in the
implementation of VAT in 2005 suggest that there could be temporary disruption in sales
around the time of implementation of the new tax code, as the distribution channel takes
time to absorb the new changes and until clarity on issues like tax rates on inventory
levels emerge. Moreover, this could get exacerbated, if there is a partial state by state
rollout of GST, rather than a national roll out, as is currently envisaged.
Regulatory issues: Regulatory issues including product approval delays, unfavorable
litigation outcomes and potential future adverse inspections from USFDA are structural
negatives for DRRD.
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