Dr Reddy’s: good going but some worries on horizon

Profitability too may come under stress when sales growth slows down in the second half. Photo: Mint

Profitability too may come under stress when sales growth slows down in the second half. Photo: Mint

Analysts were bang on with their sales estimate of Dr Reddy’s Laboratories Ltd, but its profitability improved by a much higher margin. Better operating leverage and product mix contributed to a significant jump in gross margins, said the company. While that is good news, the company alerted investors to the possibility of sales growth pressures in the US in the second half.

It also disclosed a development on the Srikakulam API plant front. API, or active pharmaceutical ingredients, are the ingredients used to make a drug. This plant had been pulled up by the US Food and Drug Administration (FDA) for non-compliance.

The company said that the FDA rescinded generic drug approvals to two clients of this unit. The FDA letters state the potential OAI status of this unit at the time of approval as a reason. OAI stands for “Official Action Indicated”, the highest action indicated post-inspection, after “Voluntary” and “No” Action. Now, this could just be the FDA correcting an oversight, as those approvals were given post-inspection. Or, the potential OAI indication could mean something worse lies in store. An import alert, for instance, will be a significant setback. The uncertainty on this front has increased after this development.

Coming to its performance, sales grew by 11.2% over a year ago. The main growth driver was the US market, which saw sales rise by 32.3% over a year ago but was flat sequentially. A low base effect and the continuing benefits of new launches post-September 2014 have contributed to this growth. But that benefit will taper from the next quarter onwards. The company reiterated that it too is facing pricing pressures, cited by Lupin Ltd earlier. Thus, the second half may see some pressure on sales growth. But this outlook could change if some key product launches happen.

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The India business grew by 13.9%, which is average considering it includes the full impact of the acquired UCB brands. But the company said some sales spilled into October due to the truckers’ strike. Therefore, this quarter should see sales spurt. Europe’s growth has risen due to new products, although it’s a relatively small market yet.

There isn’t too much good news from other markets. Currency fluctuation affected sales growth in rupee terms. While “Rest of the World” markets sales declined by 22% over a year ago, it was flat in constant currency terms.

Since sales grew ahead of cost increases, its operating profit margin increased by 2.4 percentage points over the June quarter, and by 5.9 percentage points over a year ago. Profitability too may come under stress when sales growth slows down in the second half.

Dr Reddy’s net profit rose by 25.7%. That level of earnings growth was unexpected and should cheer investors. Once the initial glow fades, investors will fret over the new development on the US FDA front, and how slow could sales growth get in the second half. Its share has risen by 38% over a year ago. With expectations running high, there may be little headroom to tolerate setbacks.

The writer does not own shares in the above-mentioned companies.

[“source -livemint”]

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