Street unimpressed with Dr Reddy’s profit surge, as they worry about growth outlook & margin pressures

• Dr Reddy’s stock fell almost 7% in trade on Thursday as the earnings missed estimates.
  
• In spite of its plan to launch more molecules in FY24, brokerages see cracks in the US, which is one of its biggest markets.
  
• In the domestic market too, the pharma major has been unable to beat growth seen in the overall market.
  
• Moreover, the company is planning to invest into biosimilars and more that will increase its R&D costs and put pressure on margins.
  

One of India’s largest generic drugmakers Dr Reddy’s Labs posted a net profit at ₹960 crore against ₹97 crore a year ago in the comparable quarter, aided by exceptional income from the sale of nine dermatology brands to Eris Lifesciences.

The Hyderabad-based pharma major also said that it had posted record sales, profits and cash flow driven by its performance in the US generics market. Yet, the stock fell almost 7% in trade on Thursday as the earnings missed brokerage estimates.

“Adjusted for divestment of brands in the domestic formulation (DF) segment, Dr. Reddy’s Labs (DRRD) recorded in-line sales in 4QFY23. However, it posted lower-than-expected EBITDA/PAT due to higher opex,” said a report by Motilal Oswal. Its revenue from operations went up by 15% to ₹5,843 crore as compared to ₹5,068.4 crore in the same quarter last year.

Kotak Institutional Equities said that EBITDA missed estimates by 21%, adjusting for the one-time income from divestment. On a year on year basis, US sales rose 27% led by new launches and favourable forex movement. EU sales increased 12%, emerging markets sales grew 4% as Russia sales declined 24%. Sales in CIS remained flat as pricing benefits were offset by lower volumes.

“DRRD delivered an operating miss in 4QFY23 due to lower sales across markets, barring Europe, as well as higher marketing and R&D costs,” it said.

Beyond the star performer

The sales, margins and even market share performance of molecules beyond its best performing cancer drug gRevlimid – have been a mixed bag. As compared to the last quarter, DRRD’s 4QFY23 US sales of $312 million declined 17%.

“We estimate that ex-gRevlimid US sales were steady qoq at around $248 million, aided by market share gains in gKuvan and gSuboxone, which offset market share losses in gVascepa and gCiprodex,” said Kotak.

The EBITDA margin (including gRevlimid and excluding Eris sales) was at 21.7% for the fourth quarter, which declined around 800 basis points from the last quarter. It indicates gRevlimid’s disproportionately high contribution, believes Nuvama. “Excluding gRevlimid, core EBITDA margin was about 15%,” the brokerage said.

However, going ahead the company plans to launch 25-30 molecules in FY24 that includes peptides along with gPentasa, gCopaxone and gVenofer. It also plans to ramp-up in gAmitiza, gNuvaring, gRemodulin and gLexiscan.

“However, on an elevated US base, given the slow pace of complex launches, we remain concerned about DRRD’s ex-gRevlimid US growth outlook,” said Kotak.

Margin pressures ahead

Despite gRevlimid strength, Nuvama says that cracks are showing up in core US business and new launches can drive – at best – single-digit growth. Added to that, DRL’s domestic sales have not been consistent or even beating the market in spite of the management’s investments. India sales grew 9.6% year on year for the quarter.

Moreover, there are concerns about the margins too in spite of the management guiding that they would remain at 25% in the medium term for the year ahead. In the last two years, margins have fluctuated between 17-23% in the last two years, said Kotak.

In addition, the company is entering a period of investments with complicated products like biosimilars, injectables, Horizon 2 assets and more to fund its next leg of growth, which means that core margins are likely to remain under pressure – another factor that’s making wary of DRL’s prospects in spite of its Q4 performance.