No immediate respite seen for Dr Reddy's

With concerns on US FDA and profitability under pressure, stock price may remain range-bound

While not much was expected from Dr Reddy’s March quarter results, the higher-than-estimated decline in profitability was a disappointment. With US FDA-related issues remaining unresolved, the near-term outlook continues to be subdued. 

Revenues at Rs 3,554 crore for the March quarter were down 5% year-on-year (y-o-y), and were lower than Rs 3,683 crore estimated by analysts polled by Bloomberg. This was the fifth consecutive quarterly decline on a y-o-y basis, in revenues. Earnings before interest, tax, depreciation and amortisation (Ebitda) at Rs 630.3 crore fell well short of expectations of Rs 779 crore. Consequently, net profit at Rs 312.5 crore was significantly lower than estimates of Rs 385 crore. 

The major pressure point continues to be US sales. With the company’s three Indian facilities under the US FDA’s warning letter, approvals for new product launches have been delayed, thereby impacting the company’s growth. Since US generic sales contribute 43% to overall sales, the decline of about eight% sequentially and 19% y-o-y in the March quarter, is worrisome. Apart from regulatory issues, the company is also facing higher competition. Dr Reddy’s attributed the decline in North American revenues in FY17 to increased competition in the anti-viral Valganciclovir, leukaemia treatment Decitabine and Azacitidine, and discontinuation of the McNeil business.

Some respite was provided by other geographies. For instance, domestic revenues (about 16% to top line) grew 8% y-o-y. Even emerging markets as Russia, CIS, Romania and rest of the world sales (17% to top line) grew 25%. However, these were not enough to pull up global generics sales (over 80% of top line), which fell 5% y-o-y in the March quarter.

Hence, going ahead, all eyes remain on clearance of the above-mentioned three Indian plants to drive growth. Unless these plants are cleared, analysts don’t expect an increase in the pace of new product approvals for launch in the US. These facilities have been re-inspected by the FDA in the past few months. While the Duvvada and Srikakulam facilities together contribute about 10% to US revenues, the Miryalaguda facility contributes about two%. Although the Miryalaguda and Srikakulam inspections concluded with no material observations or violations of rules, the issues raised at Duvvada appear concerning, say analysts. 

Analysts at Motilal Oswal Securities said it was unclear whether all three plants can come back on track together or each plant will be looked at separately.

Besides the three facilities, another plant of Dr Reddy’s at Bachupalli was inspected by the US FDA in April. Bachupalli, Dr Reddy’s largest formulations facility supplying to the US and accounting for 60-65% of US revenue, has also received observations through Form 483. However, these do not involve data integrity issues, according to analysts.

In this backdrop, analysts are cautious over Dr Reddy’s near-term prospects. Amey Chalke at HDFC Securities thus, expects the stock to remain range-bound.