How a change in proprietary strategy is yielding results for Dr Reddy's

As part of its strategy to rationalise costs, Dr Reddy’s Laboratories recently announced it has divested two proprietary neurology brands. The company had already divested four dermatology proprietary products in 2018-19 (FY19). 

Under the current agreement with Upsher-Smith Laboratories, LLC, the company will receive $70 million upfront and $40.5 million in near-term milestones.  Further, it will continue to receive sales-based royalty on a quarterly basis.

Analysts say that the sales proceeds of $110 million in upfront consideration and milestone payments should eventually finance proprietary products’ research & development (R&D) expenditure for the next two years — a step towards making proprietary products business self-sustainable. Analysts at Edelweiss Research estimate this will add 100 basis points to operating profit margin, as the company is likely to save $25 million in commercialisation cost.

With these divestments, company’s proprietary drug arm in the US will not have any commercialised products. However, the move will help improve overall margins, as analysts estimate the business to be incurring annual losses of $20-25 million. 

Dr Reddy’s has changed its proprietary strategy, which will help it to reduce earlier losses and fund R&D-driven development of new products and monetise the same. The company is believed to have about five products in late-stage clinical development currently and is also looking at building this pipeline. 

The strategy of cost rationalisation has helped improve overall profitability. FY19 had seen significant challenges on US growth due to increased pricing pressure amid higher rate of approvals and channel consolidation, the regulatory issues pertaining to Indian plants also continued, leading to delayed product approvals and launches. 

However, the company still reported strong improvement in profitability in the last financial year, with earnings before interest, tax, depreciation, and amortisation growing 37 per cent year-on-year, in spite of the US generic sales declining by about 8 per cent year-on-year. The better profitability also led to improved free cash flows in FY19 (Rs 2,240 crore), compared to Rs 710 crore in 2017-18, leading to reduction in debt by about Rs 1,500 crore. 

The growing business in emerging markets, supported by growth in India and cost rationalisation efforts, remain key growth drivers. The company is believed to be focusing more on domestic and emerging markets’ growth as well as expanding in China, where it already has a presence and an understanding of local regulatory requirements. The higher exposure to more stable domestic market can help the company command better valuations, compared to US market that remains volatile.

Dr Reddy’s focus on US markets through specialty products and divestment of proprietary products is thereby looked at in a positive light. Analysts feel confident about the company’s prospects, given ongoing business model optimisation efforts that continue to benefit. 

In the US too, the company has one of the most attractive Abbreviated New Drug Application pipeline amongst peers, which should deliver, feel analysts. Recent launches of interesting products like generics of antibacterial Cubicin, anaesthesia dug Propofol highlight the potential of the pipeline, say analysts at IDFC Securities, who also believe that operationally Dr Reddy’s has turned the corner and the worst is behind it.

Analysts at Edelweiss Securities, too, say that with focused management, promising complex pipeline, strong earnings revival, and compelling valuations, Dr Reddy’s remains a strong growth story over 2020–21. 

Among further triggers is the resolution of regulatory issues at Srikakulam and accelerated approval for key products such as contraceptive NuvaRing, which can provide further impetus and improve earnings outlook.