Dr Reddy: Powered by Merck

Dr Reddy's will focus on driving synergies from recent acquisitions to combat pricing pressure

Dr Reddy's Laboratories June 2006 quarter results indicate that its efforts to expand its low-risk contract manufacturing business, coupled with its authorised generic sales for Merck have shown signs of paying off.

The company has seen its consolidated operating profit expand 290 per cent y-o-y at Rs 252.03 crore in Q1 FY07, as compared to a 150 per cent growth in total operating income (net sales plus license fees and service income) to Rs 1349.12 crore.

However, the results of the last quarter are not strictly comparable with those of a year earlier, as the company had recently acquired Germany-based generics player betapharm and Mexico-based Falcon.

Nevertheless, the consolidated operating profit margin of the combined entity expanded 674 basis points y-o-y to 18.68 per cent in Q1 FY07.

In the key North American generics markets, the company's revenues rose to Rs 430.4 crore Q1 FY07 as compared to Rs 30.6 crore a year earlier.

Growth in the last quarter has been largely powered by authorised generics such as Zocor (medication for treating cholesterol problems) and Proscar (medication for treating benign prostate hyperplasia) for Merck.

No doubt, Dr Reddy's European generic sales expanded thanks to its acquisition of betapharm, but an area of concern is that pricing pressure is also being felt in the German generics market.

Given the changes in the German generics market, the company's acquisition price of euros 480 million appears high, according to analysts.

Meanwhile, its contract manufacturing business expanded to Rs 141.8 crore in Q1 FY07 as compared with Rs 7.2 crore in the previous year, thanks to its earlier Mexican acquisition.

Going forward, the management focus will be on driving synergies from its recent acquisitions to combat the pricing pressure. However, with the stock trading at about 24.3 times estimated FY07 earnings, the upside seems limited.

Tyre companies: Slippery pitch

Rising rubber prices and the inability to pass on higher costs to customers have affected tyre companies in the June quarter. This is despite a huge sales growth of 33 per cent and 25 per cent at Apollo Tyres and MRF respectively on the back of strong automobile sales and even a price rise of about 9 per cent for both players in the June quarter.

Operating profit margins have been under severe pressure. Apollo Tyres saw its operating profit rising just about 7 per cent y-o-y with the operating profit margin declining by 185 basis points to 7.5 per cent. In case of MRF, there was a 55 basis point improvement in the margin, but at 6.08 per cent, the margin remains small.

Natural rubber prices rose by 50 per cent y-o-y in the June 2006 quarter and hit new highs in May. Also, prices of other raw materials such as synthetic rubber and carbon black have gone up.

For Apollo, raw material as a percentage of sales increased by nearly 600 basis points in June 2006, though for MRF it was the same as in June 2005 quarter.

While OEMs may take some more price hike, it will not be easy to raise prices in the replacement market again after the recent hikes and given the severe competition. Rubber prices have also fallen from the Rs 106-107 a kg at the end of June to about Rs 93 a kg now, so that should help tyre manufacturers to some extent.

However, higher crude oil prices will continue to push raw material costs higher. Volume growth remains strong but if tyre companies cannot pass on higher raw material costs, profitability is likely to be under pressure.