Dr Reddy's stock: Good Q2, positive outlook, drug launches are key triggers

Dr Reddy’s Laboratories’ (DRL’s) better-than-expected September quarter (Q2) profits helped Street sentiment as the stock closed up 0.4 per cent, even as the markets were volatile and fell by a per cent. The outlook too appears healthy, driven by cost efficiency measures and new drug launches.

For Q2, DRL’s net profit at Rs5.04 billion, up 77 per cent year-on-year, beat Bloomberg consensus estimates of Rs 3.36 billion by a mile. Even after excluding exceptional gains of Rs 464 million on account of sale of rights in the proprietary brand, Cloderm, and profit on the sale of an antibiotic plant in Bristol, the UK, the profit from business activities was ahead of expectations.

Gross margins improved 170 basis points (bps) to 55 per cent over the year-ago quarter and analysts attribute the same to cost rationalisation efforts, better profitability in the pharmaceutical services and active ingredients (PSAI) segment and good growth in developing markets. Rising raw material prices in China is helping Indian manufacturers earn better realisations for their active ingredients produced, and this trend may continue. PSAI sales (16 per cent of Dr Reddy’s revenue) grew 7 per cent year-on-year and 11 per cent sequentially.

Amongst geographies, its US business (largest revenue contributor at 38 per cent) is still not out of the woods and facing pricing pressure and regulatory issues. In this backdrop, the 0.4 per cent year-on-year decline in revenue appears encouraging. While the rupee depreciation helped, the US business is showing signs of stabilisation, say analysts. The sequential 10 per cent US sales decline is largely due to the absence of generic Subaxone (opioid treatment drug), launched in June quarter but withdrawn later following orders from US court.

Eight per cent growth in domestic business and 36 per cent year-on-year surge in emerging markets (EMs) sales (both about a fifth of revenues) were other positives. The only disappointment came from Europe, where sales fell by 21 per cent year-on-year despite favourable currency movement. But, as its revenue contribution is small at 5 per cent, the impact on overall numbers will be limited.

DRL’s Q2 revenues at Rs 38 billion grew 7 per cent year-on-year, but operating profit at Rs 8.6 billion was much better than Rs 6.9 billion in the year-ago quarter as well as Rs 8 billion in the previous quarter.

Ranvir Singh at Systematix Shares is encouraged by DRL’s cost rationalisation efforts and said positive surprises came from a strong recovery in EMs and India, and an 850 bps year-on-year expansion in gross margin of the PSAI segment.

Moving forward, as analysts keep track of regulatory clearances for DRL’s facilities under warning letter from the US FDA, they are also hopeful of a better second half led by a few meaningful launches of generics such as Gleevec (myeloid leukaemia drug) and Nuvaring (pregnancy protection). News on re-launch of Subaxone and Copaxone too would provide triggers.

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