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Dr Reddy’s goes long on research

LiveMint logoLiveMint 13-05-2014 Ravi Ananthanarayanan

Indian generic drug makers have to keep up a steady pace of drug launches, chiefly in the US market, in order to maintain sales growth and profitability. Having plucked low-hanging fruits, newer products are more complex, and therefore their research budgets are expanding.

Dr Reddy’s Laboratories Ltd, for instance, saw its research/sales ratio jump to 9.4% in FY14 from 6.6% in the earlier year. But what can worry investors is that in FY15, it expects this ratio to increase further to 10-11%. That is a significant jump in a short period of two years.

Now, it has not given any guidance on FY15 revenue, leaving investors in the dark about the impact of these higher spends on margins. All that the company management said, in a post-conference call, was that they expect the growth momentum to continue.

But the Street may take that with a pinch of salt, as the fourth quarter results fell short of its estimates. Consolidated sales rose by only 4.2% to `3,481 crore in the March quarter over the year-ago period. Gross profit did increase by 18.3% but a sharp increase of 71% in its research expenditure contributed to a 14.5% decline in its Ebitda. The company’s net profit declined by 15.6%. Ebitda stands for earnings before interest, taxes, depreciation and amortization.

Now, the good news is that Dr Reddy’s Laboratories’ global generics business is still in good shape, with revenue growing by 21.1%. The US market’s sales growth of 31.1% continues to lead growth and its India business too did well with an 18% sales growth. But the Russia and Commonwealth of Independent States region saw flat growth, due to currency-related effects on the business.

But the real blow came from the PSAI business (pharmaceutical services and active ingredients), which saw sales decline by 34.7% year-on year, though the company pointed to the sequential increase as a positive sign. The company expects this business to do better after a few quarters. Now, some of these issues on the business front are not new. But the magnitude of the step-up in research spends is something that investors will have to contend with. Dr Reddy’s Laboratories needs revenue growth to step up in FY15, especially in the US market where it will need its existing products and new launches to support growth. If other regions and its PSAI business also put their shoulder to the wheel, then the task may become easier.

Dr Reddy’s Laboratories is doing the right thing by investing in research, as that can provide sustainable long-term growth. But returns will take time to show up and are also uncertain. Investors may just decide to become cautious, till they can see which direction the company’s revenue growth heads in FY15. On Tuesday, after its results were announced, its share was down by 4% on a day when the broad market gained by 1.4%.

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