Dr Reddy's: Not too well

High operating costs have hurt profits.

A 25 per cent growth in drug major Dr Reddy's top line in the June 2008-09 quarter wasn't enough to offset the soaring selling and administration costs, which jumped 510 basis points.

The operating profit margin crashed to 9.5 per cent, a loss of 540 basis points over the June 2007-08 quarter. At 31 per cent of revenues, the Rs 5,006 crore Dr Reddy's bloated sales cost base is hurting profitability.

Sales for the Hyderabad""based firm, at Rs 1,503 crore, were driven by a strong 35 per cent growth in the domestic active pharmaceutical ingredients (API) business.

Exports of formulations were up 19 per cent, doing brisk business in the Russian and CIS markets. However, they didn't sell too well in the home market, up just 9 per cent and below the industry average.

Also, despite higher volumes of 33 per cent "" the result of better supply chain efficiencies "" Betapharm, the German subsidiary, posted flat revenues in euro terms. That reflects the severe price erosion in the German market where Betapharm has taken price cuts of about 6-7 per cent.

Betapharm contributes about 16 per cent to total revenues and the lower prices are likely to impact profits in the coming quarters too. Meanwhile, Dr Reddy's has started shifting production from Germany to India to try and leverage its domestic manufacturing facilities more effectively to make the German operations more profitable.

With a diversified generics portfolio and several first-to-file products, Dr Reddy's has a balanced revenue model. The management maintains that it will grow revenues at 25 per cent this year.

However, the stock could continue to trade at a discount to its peers, given the concerns about Betapharm and the sluggish sales of formulations in the domestic market, which the management has attributed to delayed new launches and maturing products.

At Rs 632, the stock trades at 17.5 times estimated FY09 earnings, which are tipped to grow by about 29-30 per cent over FY08.