Emerging markets keep up the growth tempo for Dr Reddy’s Laboratories

  • The company is also building new service lines such as hospitals and other business verticals on a B2B model 
  • Gross margin softened during the quarter, reflecting continuous price erosion in its key US market

Shares of Dr Reddy’s Laboratories Ltd gained 3.3% on Friday after the company’s earnings for the December quarter exceeded analysts’ estimates. Growth momentum in emerging markets coupled with cost- rationalization measures are expected to help Dr Reddy’s maintain the earnings tempo.

Revenue in the December quarter increased just 1%. However, as the company kept a check on operating expenses, including spending on research and development, operating profit increased 7.4%.

Gross margin softened during the quarter, reflecting continuous price erosion in its key US market. But the loss in the US market is being more than made up for by growth in emerging markets and in India. Further, Dr Reddy’s custom pharmaceutical services business had a good quarter, shoring up earnings.

The net result at the company level is positive revenue growth for the third straight quarter. Importantly, Dr Reddy’s sees stabilization at the portfolio level, largely aided by continuing growth momentum in emerging markets and limited-competition opportunities in the US. Limited-competition opportunities are with reference to certain complex drugs that offer better realizations due to less competition.

As the company maintains its focus on cost-rationalization and efficiency- improvement measures, analysts see a stable earnings trajectory. “We raise our FY19/20/21 earnings per share estimates by 6%/4%/3% to factor in better growth in emerging markets, cost-rationalization measures and lower tax," Motilal Oswal Securities Ltd said in a note.

Growth in emerging markets is being driven by market expansion. The company is not only expanding its reach but also building new service lines such as hospitals and other business verticals that largely work on a business-to-business (B2B) model.

That said, as with most global generic drug firms, Dr Reddy’s fortunes are intertwined with that of the US, the largest drug market. The US market continues to face pricing pressures. Last quarter, higher volumes helped the company alleviate the revenue impact; its revenues grew 4% sequentially.

Dr Reddy’s focus is on new product launches and limited-competition opportunities. In the current quarter, the company expects to step up product filings.

If approved in time, the limited-competition drugs could lift US revenue next fiscal (year). But much of the benefit will also be linked to resolution of the regulatory issues at its manufacturing plants, key to cost-effective production.

“Dr Reddy’s has taken significant remediation measures and awaits a response and/or re-inspection from the US Food and Drug Administration for sites under the warning letter," added analysts at Motilal Oswal. “Given the uncertain nature of time-lines taken by companies to resolve regulatory issues, we wait for successful compliance at (these) sites."

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