Analysis Report : Dr. Reddy’s Laboratories Limited (Estimated Price : Rs.2600 per share)

Dr Reddy’s Laboratories Limited (NSE CODE- ISIN: INE089A01023; BSE CODE- 500124) is an integrated global pharmaceutical company committed to providing affordable and innovative medicines through its three core business segments: Global Generics, Pharmaceutical Services and Active Ingredients and Proprietary Products.

Global Generics- Global generic is the company’s biggest business driver .this segment is committed to make products affordable. Company achieve this by bringing expensive medicines within the reach of patients by reducing the cost of therapy. Company offer over 200 high quality and reasonably priced generic versions of expensive innovator medicines by leveraging Company’s integrated operations. Revenue from this sector is increased by 27% to ₹105164mn combining from all the boundaries including North America, Russia, and India.

Pharmaceuticals Services & Active Ingredients- The company is one of the global leaders in supply of generic Active Pharmaceutical Ingredients (APIs). Company create high-quality enabling Company’s customers to create end formulations for patients that are effective and safe. Company has emerged as one of the world’s largest producers of APIs and help innovator companies launch its products first in the market. Apart from helping customers capture market opportunities at the earliest, APIs also help their own generics business reach consuming markets faster and become cost-competitive.

Proprietary Products- This segment comprises of New Chemical Entities (NCEs), basically to meet the unmet medical needs of the company. Main focus of this segment is to build sustainable and profitable proprietary producst through strong pipeline of differentiated formulations. New products were launched in FY2014, of which 9 were launched in the US, 11 in Europe, 23 in Emerging markets and 11 in India.

Biologics- Biologics represent the next step in the evolution of modern medicine where medicines are produced from living organisms and biological processes using biotechnology.

Following are the key products of the company according to different geographies:

 

The ground drivers of the future growth of the company are-

·       Purpose of providing affordable and innovative medicines

·       Customer value proposition like-

o  Bring Specific medicine within reach

o  Address unmet patient needs

o  Help patients manage disease better

o  Equip partners to succeed

o  Ensure products are always on shelf

·      Key strategic choices like-

o  First-to-market, Tough-to-make products

o  Differentiated formulations for unmet medical needs

o  Value added services for patients and customers

o  Reliable & flexible supply chain

Apart from these drivers, following are the variables showing the future growth potential of the company

 

Research & Development-The Company’s target is to steadily introduce innovative medicines- oral formulations or injectables. Company is also looking forward to attain a good position in R&D.

 

Contribution in R&D Department-
India is facing a diabetes epidemic with 67 million confirmed diabetes patients and another 30 million in the pre-diabetes group. By 2030, India will have the largest number of patients in the world. Company developed a solution for an acute need, where the existing drug was an issue in itself! Metformin is the first in line medicine for the treatment of patients suffering from Type-2 diabetes. The pill is very big and hence uncomfortable to swallow. But it had come to be accepted by doctors and patients, given that there was no alternative.
Since 1989, many companies had been attempting to make a smaller version of the pill but few had succeeded. The major technical hurdle was reducing the size while ensuring the right quantity of the drug was available in the blood stream. Recognizing a silent need that many had overlooked, company decided to create a smaller pill that still packed in the same impact. Company did this by working together with its R&D, formulations, and IP and marketing teams. It came up with Metsmall®, named after the solution and we got it to market at the earliest. And as a result, there was 33% reduction in size; 36% reduction in weight.
Biologics- is an exciting future opportunity for Company as a large number of biotech drugs (USD 75-85billion) are coming off patent in 2020. Company’s current biologics portfolio covers most of the top biologics coming off patent. In addition Company also entered into an alliance with Merck Serono, a division of Merck KGaA, Germany, in 2012 to co-develop a portfolio of bio similar compounds in oncology; which is primarily focused on Monoclonal Antibodies (MAbs). It covers co-development, manufacturing and commercialization of the compounds globally, with some specific country exceptions. This alliance maximizes the complementary capabilities and assets of both companies and offers a risk mitigation pathway for Company to take its development capabilities through the clinical phase and then into commercialization.

Growth will arise from different factors in the developed and pharma emerging markets. Major factors shaping demand in developed markets include:

• The shift to generics: A large proportion of spending is steadily moving to generic drugs. In the US, 34% of 2012 brand spending, or US$ 83 billion in value, will shift to generics at substantially lower prices. In Canada, this proportion will be 30%. And in other developed markets, 22% of average brand spending will be exposed to generics competition. 
• Increased access to medicines in the US due to healthcare reform: The Patient Protection and Affordable Care Act in the US aims to extend public and private insurance coverage to an increasingly larger share of the population. Once fully implemented, it will increase the access to medicines for the public, which should boost demand.

CHALLENGES:-
1. Economic Instability-
Post economic slowdown, the economic indicators are improving but at a very low rate than expected. Growth is very slow in both the developed and developing economies, which has created uncertainty about how global economies will shape up in near future with their corresponding impact on global pharmaceutical industry.
2. Barriers to the Competition-
In some emerging markets and even in developed nations, there has been a rise in use of tariff and non tariff barriers in order to protect domestic manufacturers from the direct foreign competition.
For example, in 2009, Russia initiated its ‘Pharma 2020’ program with the goal to increase the share of locally produced medicines up to 50%. Such interventions are expected to intensify in some developed and pharma emerging markets and,
therefore, may affect global pharmaceutical companies that export to several regions.

EMERGING MARKETS: RUSSIA, CIS AND THE REST OF THE WORLD (ROW) 
According to the IMS, the Russian pharmaceutical market is expected to grow at a CAGR of 12% between 2012 and 2017; Dr. Reddy’s CIS presence is in Ukraine, Kazakhstan, Uzbekistan and Belarus. Revenues from other CIS countries grew by 22% to `3.5 billion in FY2014. Rest of World (ROW) for Dr. Reddy’s includes markets like Venezuela and South Africa which have experienced high growth rates in the past few years — in addition to Australia, New Zealand and markets in Southeast Asia. Venezuela has been one of the fastest growing ROW geographies for Dr. Reddy’s with a growth of 53% compared to the previous year. This has taken place notwithstanding numerous challenges such as: (a) sharp currency devaluation, (b) continued protests against the incumbent government, (c) massive inflation running at over 60% per annum and (d) an unsettled and agitated population due to periodic non-availability of essential goods. India’s pharmaceutical market is expected to grow at a CAGR of approximately 16%, driven primarily by favourable demographics including country’s aging population, changing disease profiles, growing affluence and disposable income and increasing provider penetration.

FINANCIALS
Annual Revenues from Operations for the financial year 2013-14 increased by 12.78% to Rs. 13415.30 crores. EBIDTA margins improved to 25.50% from 24.12% last year to Rs. 3420.50 crores. This improvement in margin happened on account of decrease in material costs which came out to be 21.18% of operating revenue as compared to 23.68% last financial year. Interest cost has lowered down to 3.06% of operating revenue from 3.17% last year. Research & Development cost has increased to 9.42% of operating revenue from 6.65% the previous year. Profit after tax improved to 14.63% of operating revenue at Rs. 1963.20 crores from 12.83% last year.

Summarized P&L for previous five years

Rs in crores	2010	2011	2012	2013	2014
Revenue From Operations	7031.00	7496.90	9814.50	11895.60	13415.30
EBIDTA	1520.90	1605.50	2563.40	2869.40	3420.50
Finance Cost	31.2	24.6	105.6	100.3	126.7
Depreciation	413.1	398.1	518.1	550.2	647.5
Profit Before Tax	618.3	1182.8	1804.4	2164.7	2646.3
Current Tax Expense	266.8	210.6	524.8	657	656.8
Profit After Tax	351.50	998.90	1300.90	1526.80	1963.20

Debt/Equity ratio deteriorated to 0.53 in the financial year 2013-14 from 0.50 last year on account of build-up in loans. Return on Capital Employed (RoCE) improved to 13.01% this year as compared to 11.98% last year. Working Capital dynamics has deteriorated in the financial year 2013-14. The Days Inventory Outstanding (DIO) has increased to 256.86 days from 217.39 days last year. The Days Sales Outstanding (DSO) has stayed same at around 90 days. The Days Payables Outstanding (DPO) has increased to 94.75 days this year from 86.77 days last year. Overall, Cash Conversion Cycle (CCC) has increased to 166.16 days in the financial year 2013-14 from 134.63 days the previous year.

                                                    Ratio analysis for previous five years

	2010	2011	2012	2013	2014
Debt/Equity	0.39	0.59	0.65	0.50	0.53
RoCE	0.09	0.11	0.13	0.12	0.13
Payables in Days	-	52.78	95.17	86.77	94.75
Recievable turnover days	-	71.15	82.80	90.78	90.14
Inventory in Days	-	264.26	257.07	217.39	256.86

Summarised Balance Sheet for previous five years

Rs in crores	2010	2011	2012	2013	2014
Share Capital	84.4	84.6	84.8	84.9	85.1
Reserves & Surplus	3692.4	3947.3	4904.2	6284.2	7780.1
Long Term Borrowings	1484	537.2	1641.9	1265.9	2075.5
Total Long Term Liabilties	1559	722.7	1743.8	1459.3	2374
Short Term Borrowings	1674.6	1831.9	1588.8	1898.6	2060.7
Trade Payables	0	634.5	756.6	965.7	893.2
Total Current Liabilities	2024.8	4208.5	4591.4	5658.8	5790.4
Total Liabilities	7360.6	8963.1	11324.2	13487.2	16029.6

Total Net Block	2330.5	3385.5	3411.7	4050.6	4640.8
Total Non Current Assets	3540.4	4148.1	4325.2	4960.5	5703.9
Inventories	1339.4	1599.2	1943.3	2170.7	2418.8
Trade Balance	0	1761.1	2536.8	3180.4	3325.3
Cash And Bank Balances	660	575.1	1606.1	2017.1	2300.6
Total Current Assets	3820.2	4815	6999	8526.7	10325.7
Total Assets	7360.6	8963.1	11324.2	13487.2	16029.6

In the September quarter for the financial year 2014-15, Net Income has increased by 6.86% to Rs. 3587.81 crores from Rs. 3357.45 crores year-on-year. Raw materials as a percentage of Net Income has improved to 21.08% from 29.39% y-o-y. But Other Expenses increased to 17.95% of Net Sales from 15.63% y-o-y. R&D expenses increased to 11.46% of Net Sales from 8.96% y-o-y. All this had bearing on Operating Profit which dropped to 18.02% of Net Sales from 21.92% y-o-y. Tax rates increased to 17.25% from 10.30% for the September quarter y-o-y. Thus, Net Profit also dipped to 16% from 20.56% for the September quarter y-o-y.

In terms of valuation, diluted EPS for the financial year 2013-14 stands at Rs. 114.94. PE comes out to be 27.94.

Projected P&L for next five years

Rs in crores	2015	2016	2017	2018	2019
Revenue From Operations	15265.71	17371.36	19767.44	22494.02	25596.68
Total Expenses	11566.52	13161.92	14977.39	17043.26	19394.09
EBIDTA	3699.19	4209.43	4790.05	5450.76	6202.60
Finance Cost	135.71	154.83	176.72	201.78	230.47
Depreciation	688.09	814.62	956.40	1116.18	1297.09
Profit Before Tax	2875.39	3239.98	3656.93	4132.80	4675.04
Current Tax Expense	713.66	804.15	907.63	1025.74	1160.32
Profit After Tax	2161.73	2435.83	2749.30	3107.06	3514.71

It is expected that revenues of Dr. Reddy’s Laboratories are going to increase at a rate of 14% y-o-y. To estimate the valuations, Discounted Cash Flow method has been used. Value per share comes out to be Rs. 2600. Current Market Price is at Rs. 3213.

Projected Balance Sheet for next five years

Rs in crores	2015	2016	2017	2018	2019
Share Capital	85.1	85.1	85.1	85.1	85.1
Reserves & Surplus	9616.0603	11684.813	14019.79	16658.614	19643.66
Total Equity	9701.1603	11769.913	14104.89	16743.714	19728.76
Long Term Borrowings	2085.3365	2386.2291	2732.6827	3131.8414	3591.9963
Total Long Term Liabilties	2383.8365	2684.7291	3031.1827	3430.3414	3890.4963
Short Term Borrowings	2344.9384	2668.3825	3036.4403	3455.2653	3931.8601
Trade Payables	963.2444	1096.1075	1247.2968	1419.3401	1615.1138
Total Current Liabilities	6144.6827	6600.99	7120.2371	7711.1054	8383.4739
TOTAL LIABILITIES	18229.679	21055.632	24256.31	27885.161	32002.73

Total Net Block	5559.2414	6581.4874	7726.9904	9017.8867	10479.474
Total Non Current Assets	5983.5414	7005.7874	8151.2904	9442.1867	10903.774
Inventories	2611.2715	2971.4518	3381.3128	3847.7072	4378.4326
Trade Balance	3770.039	4290.0515	4881.7908	5555.1504	6321.3885
Cash And Bank Balances	3583.8275	4507.3411	5560.9158	6759.1162	8118.1349
Total Current Assets	12246.138	14049.844	16105.019	18442.974	21098.956
TOTAL ASSETS	18229.679	21055.632	24256.31	27885.161	32002.73

This report has been prepared by Ayush Soni , who is pursuing MBA from Institute of Management, Nirma University located in Ahmedabad, India.

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