By Sarabjit Kour Nangra, Sushant Dalmia (Angel Broking)

Performance Highlights

- Net Sales spike by 14%: Dr Reddy’s Laboratories (DRL) reported Net Sales (as per Indian GAAP) of Rs1,800.4cr (Rs1,575.9cr), which grew by 14.2% and were ahead of our estimate of Rs1,698.7cr. The robust performance on the top-line front was mainly driven by the North American, Indian and Russian markets. On the Global Generic front, the North America region grew by a stellar 36.5% to Rs428.5cr (Rs314.0cr), driven by volume growth and new product introductions. India grew by 12.7% to Rs252.0cr (Rs223.7cr), while the Russia & CIS region grew by a strong 26.3% to Rs234.7cr (Rs185.8cr) driven by price increases. During the quarter, the Europe region de-grew by 13.4% to Rs284.9cr (Rs329.1cr), primarily on the back of a weak German market; Germany de-grew by 21.4% to Rs220.0cr (Rs 280.0cr), on the back of lower sales due to AOK tender and pricing pressure in the market. On the PSAI front, Europe grew by a whopping 49.7% to Rs176.1cr (Rs117.6cr).

For 1HFY2010, DRL’s Net Sales (as per Indian GAAP) grew by 17.1% to Rs3,579.2cr (Rs 3,057.2cr), driven by the North America region.

- Operating Margin expands by 413bp: DRL reported an OPM of 16.8% (12.6%), which was higher than our estimate of 15.2%, on the back of robust sales growth and lower Other expenses. DRL’s R&D expenses degrew by 3.4% to Rs95.2cr (Rs98.6cr), on account of lower ANDA filings during the quarter, while Other expenses de-grew by 2.5% to Rs293.2cr (Rs300.8cr), due to cost savings. For 1HFY2010, the company reported an OPM of 19.4% (13.0%), which was up by 637 bp.

- Net profit jumps by 177%: For the quarter, DRL reported a Net profit of Rs239.8cr (Rs86.6cr), on the back of a higher sales growth and OPM expansion. For 1HFY2010, DRL reported a Net profit of Rs478.7cr (Rs 178.9cr), up by 167.6%. 

Business Performance

Global Generic

DRL’s Global Generic business registered a 14.3% growth in Revenue during the quarter to Rs1,270.7cr (Rs1,111.5cr). For the 1HFY2010, Sales were up 20.2% to Rs2,572.7cr (Rs2,140.2cr)

North America

The North America Region grew by 36.5% to Rs428.5cr (Rs314.0cr) and was higher than our expectation, driven by volume growth and new product launches. On robust volumes, Management indicated that several manufacturers in US had issues with manufacturing processes, while DRL did not face any; hence, it was able to cater to the demand. Sumatriptan contributed less than US $10mn during the quarter, on account of increasing genericisation, and its contribution to the margins was minimal on account of price adjustments. The company also launched Nateglinide with limited contribution during the quarter. DRL has cumulative ANDA filings of 141, while 62 ANDAs are pending approval, of which 27 are Para IVs and 16 are FTFs. For 1HFY2010, Net sales grew by a strong 73.4% to Rs1,031.1cr (594.8cr), on the back of a higher contribution from Sumatriptan in 1QFY2010 and volume growth in 2QFY2010.

Europe

During the quarter, the Europe region de-grew by 13.4% to Rs284.9cr (Rs329.1cr), primarily on the back of a weak German market; Germany de-grew by 21.4% to Rs220.0cr (Rs 280.0cr), on the back of lower sales due to AOK tender and pricing pressure in the market. DRL indicated that the Rest of Europe grew by 29.0% to Rs654.0cr (Rs507.0cr). The Management indicated that pricing pressures would persist in Germany, and few new tenders are likely to open in 3QFY2010 that would be bid for by DRL. 

Russia and CIS

The Russia and CIS region grew by 26.3% to Rs234.7cr (Rs185.8cr), with Revenue from Russia growing by 38.4% to Rs184.5cr (Rs133.3cr), on the back of price increases, while revenue from other CIS markets fell by 4.4% to Rs50.2cr (Rs52.5cr).

India

Revenue from the Indian Domestic Formulation business grew by a healthy 12.7% during the quarter to Rs252.0cr (Rs223.7cr). The higher-than expected growth came on the back of strong traction witnessed in the company’s key brands, Omez, Omez-DSR and Razo. DRL launched 17 new products during the quarter.

Pharmaceutical Services and Active Ingredients (PSAI) Segment

The PSAI Segment grew 11.4% to Rs537.5cr (Rs482.7cr), driven mainly by the Europe region, which grew by 49.7% Rs176.1cr (Rs117.6cr), and by rupee depreciation during the quarter. Global cumulative DMFs of the Segment stood at 361 at the end of the quarter.

Other Key Takeaways

- DRL incurred capex of Rs140cr during 1HFY2010.

- During the quarter, the company made an inventory provision of Euro 6mn in Betapharm, on account of non-moving stocks, and US $4mn on Sumatriptan for price adjustments.

- DRL’s alliance with GSK will start contributing from FY2011.

- DRL has got the tentative approval for Allegra D-24 and is the FTF holder with, a 30-month stay, expiring on 17th March 2010. DRL can either launch at risk, or enter into a settlement with the innovator on the completion of the stay. DRL also settled with Novartis on Lotrel.

- DRL expects a US FDA inspection of its formulation facility in India in November 2009. This is likely to be a key event for the company, given the recent product recalls.

Outlook and Valuation

While DRL’s 2QFY2010 numbers were ahead of our estimates, on the back of strong traction in the US base business and a picking up of the Indian formulation business, with Germany expected to remain subdued, and contingent upon winning new contracts. We have adjusted our sales estimates and earnings estimates for FY2010E and FY2011E upward by 7-22%, on the back of a robust US base business and an uptick in the Indian formulation business. DRL is currently trading at 19.3x FY2010E and 16.1x FY2011E earnings. We continue to maintain our Neutral stand on the stock given its rich valuations.