Dr. Reddy's Laboratories Limited (500124) Earnings Call Transcript & Summary

Hello, and welcome to the JPMorgan Healthcare Conference. I am Neha Manpuria, the India Health Care Analyst at JPMorgan. It's my pleasure to introduce Mr. Erez Israeli, the CEO of Dr. Reddy's. We will be having a fireside chat in this session and try to address questions on growth strategies of Reddy's. Thank you so much for joining us for this session, sir. It is a pleasure to host you. If you don't mind me directly moving into Q&A, I can start.

Sure. Thank you for having me.

So the first question that I have is Dr. Reddy's today probably has a very well-balanced business with a growing emerging market presence, improving position in India post the Wockhardt acquisition and a strong U.S. pipeline. From here on, what do you think will be the growth engines for Dr. Reddy's so sort of to achieve the aspirational return target that you have talked about in your calls?

Yes. We are on the way to get there. And so far, the strategy that we have communicated also in the past is working out nicely for us. So every one of the spaces that we discussed in the past is aiming to grow. So whether it's United States, India, Russia, emerging markets, APIs, China, et cetera. So each one of them has its own strategy and its own merit to grow. And the beauty of it that all of it is coming from a similar infrastructure that creates synergy for us. So we are trying to leverage the growth opportunity across markets in that respect. So the focus on the more products, focusing on those big brands, if it's in the branded generics or focusing on those, we call it crown jewels or whatever is the fancy name that we have for each one of them is going to continue to drive us. And actually, we just started the journey. The main growth opportunity, I believe, is ahead of us.

Fair enough. If I were to start off with your India business, there has been significant improvement in the core business in FY '19 and '20. We have now, like I said, augmented with the Wockhardt portfolio acquisition. How do we move from growing in line with the industry to beating industry growth despite the fact that we have a portfolio that is sort of skewed towards the acute segment? Will this be through entering trade generics, institutional OTC? How do you pivot that growth for the India business?

So the main growth for us is coming from a certain leadership position that we are building in about 10 spaces in India, which is primarily about therapeutic areas. So if you take just an example, so we are investing a lot in the areas of diabetics, which is a major unmet need in India, and it's growing nicely for us. It's growing also nicely as a whole. And there is a great pipeline that is coming up in that direction if it's in the areas in which we already have established brands. So we are using a different go-to-market approach in order to make those big brands bigger. And by that, enjoy a better economy of scale on those brands. The Wockhardt, by the way, served us very nicely because it goes exactly to those therapeutic areas, in which we needed certain brands and position to solidify the leadership that we have in those therapeutic areas. And indeed, it's proven that it is working. We did have come up with both sales synergies as well as cost synergies. And I'm actually very happy with Wockhardt deal that we have made. In addition to that, we are developing and using our capabilities in the specialty that was developed in the past for United States, for India. So actually, India is now the main place in which we are going to launch all of our specialty products. And actually, India first is what we are using now. And on top of it, we are investing heavily in the capability. Maybe now we moved from #16 when we initially discussed. And you remember that now we are #11. We promised top 5, we will be top 5. I think as a digital company, we are probably top 3. So we are now changing the landscape and the way we do business in India, moving to digital channels, et cetera.

So I have 2 questions from what you mentioned. Moving to top 5. The big gap, I think, from where we are versus getting to top 5 would be probably the chronic segment, which we do have presence, but probably we can strengthen further. How do you plan to address this gap? That is my first question. And then probably I can ask the second one.

We -- first, we are going into -- the organic piece will be by enhancing those brands that have a potential to reach leadership position and of course, to launch brands. That -- we'll be able to do that. It's not just in chronic, but also in the hospital and institute area. The others will be that we will continue to look for M&A opportunity in India. India is the primary market for us in terms of business development opportunities.

Fair enough. My second question on what you mentioned was the accretion from Wockhardt deal. Could the portfolio -- the margins of the Wockhardt portfolio meaningfully improve from, let's say, getting to where we are at a corporate level? I know there is scope for improvement even in the India business. But because Wockhardt has acute exposure, is there significant scope for expansion in Wockhardt? And what will be these areas?

So the Wockhardt, the brand's really good. And I think now we -- on our platform, we can serve them better, and that's what we are trying to do. So yes, the answer is yes. We -- there is room to improve the quality of the brand, the distribution and the market share of this brand as well as technologies. Absolutely.

Understood. In the last few years, the, emerging market business and India have been a key driver of the operating leverage and the margin expansion. If I were to look at the margins from here, can the India business improvement drive that margin expansion? Or do you think this would now depend probably get -- will be on the back of the U.S. pipeline? Just trying to understand if we have probably reached the peak when it comes to India margin and the focus there is to improve both.

India is not just in improving margins. It's improving our presence in India. And India being a market with relatively high margin and much more important, much better ROC is improving -- help the company to improve overall. But it's not just India. We improved our margins in all the spaces that we are there. And this is coming primarily because of productivity. And productivity is not just about cost. It's about time to market, about speed, about leverage the assets across markets. So it's a combination of economy of scale, cost and service, turnaround time, et cetera. So this is also the intent in the future. So to direct answer to your question, yes, India will grow, will expand, will have better margins. But it's a partial answer. Also, the others will do the same.

Fair enough. But particularly for India, do you think the invest -- would this growth require disproportionate investment either by the way of MR or increasing rural penetration? Or like you mentioned, investment in digital? Or do you think despite of all of these investments, there is scope for expansion?

There is a scope for expansion and, I don't see disproportional investment. The only place and maybe that we'll have to put more capital allocation is in the case of acquisition in India. And that's, of course, will be that, but other than that, it will be within the scope of the strategy that we already working on for the last 3 years.

Understood. If I may shift gears a little bit to the emerging market. One area that you've spoken about in the emerging market is leveraging your injectable pipeline for building the institutional business. Could you give us some color on the progress that we are seeing there? And by when will this start scaling up meaningfully?

So we are already -- most of the growth that we see in those markets is because of this expansion as well as in Europe, And over time, also United States. We look at institutional business, not just in MLC market, we look at it globally, like we look at API. And the idea is that every molecule, and this is including also our biosimilars that eventually goes to the same channels, we want to sell in every -- to every hospital on earth, whether with our own people or through partners if we don't have a go-to-market access. It's already started to bear fruit, but most of this portfolio is still in either development or at the time of registration. So the growth that you see now, it's already reflecting that, but it's only the initial part. There are about 50 or 60 more molecules that are coming up in the next 3 to 4 years. And every year, we are going to have those launches that are coming up in emerging markets globally. There is a big expansion of our sterile capacity in India. So we have both FT07, 9 and 11 functioning for this area, and we will continue to expand on that as well. This is the major part of our CapEx right now, the injectable business.

And if I were to look at the emerging markets, we have a very strong presence in Russia, CIS. Can we create a similar market, a similar-size market, in EM? So do you think EM would be because it's institutional, these could be all $10 million, $15 million type of market because it's institutional? We don't really set up branded businesses.

We are not planning to set up in most of the places. A significant branded business in some of those countries we have, but it's not in a big scale. I prefer to use the institutional because of the following reasons. First, most of the patent expirations are in this product. Second, it's a B2B that doesn't require SG&A. We can leverage the same file and the same experiments all over the world and get fast registration. So the -- and the level of gross margin is much higher. So it's -- if you wish, it's a faster-growing business that is relevant now for many, many of these markets. So right now, this is the main focus.

And just extending on that. China, a lot of your peers have talked about it. We are seeing -- Reddy's was 1 of the first players to increase investment in this business, the already existing investment scale it up, so to say. How far along are we in our China investment materializing? And has the investment opportunity in your view, changed because of either the CP program, the discounting levels that you've seen or the fact that you're seeing more players enter that market or trying to establish their presence in that market?

Like we have discussed in the past, our ability to be successful in China is because we are already working in China more than 20 years. And for all the people that will come into that market, they will have to -- they will discover that it's not easy to be a newcomer into the country because you do need to establish your talent, your infrastructure, your relationship with the customers, et cetera. We have already, and we started this journey 3 years ago with the -- after we've been there amount of time, we had the hundreds of employees. We have a plant, et cetera. So we've built on that. And that's allowed us already to launch products. So we are not just talking about it. We already registered many products. We already launched 2 products and participated in GLP. We already have 10 branded products that are commercially available for -- in China. So -- and it is a market that is growing in double digits for us consistently and even high level of double digits. So I'm very comfortable about China, but it's not a market that it's easy just to come. It's a market that takes time to build the relevant infrastructure, the size of the country, the nature of the market requires that level of dedication.

And given that we started investment there about, I think, in FY '19, towards the end of FY '19, should we start seeing meaningful contribution from China in the next fiscal? Or would you say it's probably another 2 years away?

So it's already started from my end. It means that whatever we invested, we are selling. And we are paying for this investment as we go. It's a very, very high level of ROC because for us, it's about primarily leveraging products that were developed in the past, et cetera. But if you ask, when do we see, let's say, meaningful higher numbers, so they will start to accumulate over the year. So every year will be more and more. So next year will be better than this year, et cetera. And of course, it depends on the pace of approvals that we will get. So for example, whatever we have now with about $150 million of sales in China comes out of the 10 branded generic, plus 2 generics. Now we have about 40, 50 products that are waiting for in certain level of registration, out of 100 that will be eventually filed for launch in the next 3 years. So whatever portion of these products that will get approval, of course, it will add to our business over there.

Understood. No, that's a fair point. Moving to the U.S. business. Some of the launches that we have seen in the last few years reflect the fact that Dr. Reddy's R&D capabilities have been superior. Has the approach to R&D changed and as we become more broad based in the U.S. generic business versus the past? And do you think that impacts the quality of the pipeline that we would be launching, let's say, 2 years from now?

I think it's improved the quality of the pipeline because the R&D became more productive. I think we changed 3 dimensions of the way we work with R&D, that is now bearing fruit. One, we -- the R&D is asked to be more productive. So we took certain measurements to have more dollars to be sold out of dollar investment in R&D. And we are doing it with various measurement of productivity. Second, we are improving the rate of success of the complex product. It was always a strategy of Dr. Reddy's to go after these products, but the rate of success was not high. And we are increasing it by making the relevant changes needed in order to improve that. Number 3, those products are leveraged globally. So even -- so we are not dependent on a customer that may buy or not buy these products in order to get a return on investments. So the entire business is built that even the U.S. market is very important. But even if the U.S. market will not buy $1 of this product, it's still a good investment on the R&D. And as the R&D is the main vehicle for our growth, it was very, very important to ensure not just the return, but also the risk profile of it that we will not be dependent on a single customer or a single situation in order to ensure the growth of the company. This also allowed the confidence to submit more products in this. Actually, accelerated the numbers of product and the submissions without dependency on the U.S., whether they will buy it or not in the future. So it's a -- if you wish, it's the strategy that allow more opportunities with less risk.

I'm tempted to ask about delay for general Vascepa. We have seen 1 of your peers launch, but the generic share has been fairly limited. It seems like there seems to be a supply constraint. Could you give us any color on our preparation for launch and when we could see that?

Yes. We are taking the relevant logistics effort to launch the product, and I believe that we will launch this soon.

And is supply constraint an issue for you?

There were logistics and supply situations that delayed, let's say, that. We are overcoming that, and we will launch soon.

Understood. Erez, one other question that I wanted to ask you is on biosimilars. The EM strategy for biosimilars is fairly clear when it comes to Reddy's. But on the regulated market front, we have talked about sort of derisking or partnering the approach to reduce the risk. Could you -- as the regulatory pathway becomes more clear, market -- we have seen market formation in quite a few biosimilars. Would you like to change the approach that Reddy's has taken for biosimilar development -- for biosimilars for regulated market?

No. Maybe, as long as in the U.S. market requires, let's call it, a front-end infrastructure, meaning sales force and stuff like that, we don't believe that we should do that because it's not sustainable. And in the longer term, there will be higher price erosions also in the United States. And the model will be closer to what we know in the other markets, I believe. So if it's more of a directly go to market, then naturally, we can do it ourselves. I'm not a big fan of building a huge sales for infrastructure. This is not for us. In those situations, I prefer to get a partner that has already that infrastructure in place.

Yes. So in the first wave, it would be fair to assume that Reddy's would be partnering out most of the pipeline?

Yes.

And other than the few assets that we know the 2 assets, does Reddy have -- is Reddy investing in building a larger pipeline for biosimilars in the regulated market?

We have about 9 products in certain levels of development in all kinds of level of development. So the answer is yes. Biosimilars is important to us. The investment is calibrated to the success in that area, and I believe that actually, most of the market long term will be from emerging markets and less from the United States.

Fair enough. Now the, let's say, the topic of the hour. Could you provide some color on Sputnik V? How are the trials progressing? Could you give any details on the time line and the capacity?

Sure. So we have -- we finished Phase II, and we are waiting for approval to go to Phase III in India on top of the readout of the global trials that RDIF made. I hope and believe that we will do it successfully. So with the success of that, we will wait for approval from the authorities to launch the products in India. So the earliest possible time, I think that we can do that is probably March. I don't see it before March. And we are gearing toward launching the quantities that were allocated for us from the RDIF. So we have an access to 125 million units of treatment, each one of the treatment and 2 vaccines. So it's 250 million of that. And I hope that we'll be able to sell all of it, if not, most of it in FY '22.

Understood. So you said it's 125 million units of treatment?

Treatments. 250 million vaccines, each 1 of the treatment requires 2 vaccines, yes.

Yes. Okay. Fair enough. And this -- the production is third party, right? It's not our own capacity that...

It's not -- we don't have those capabilities. So we are using contractors, yes.

Okay. Okay. Fair enough. Now just shifting gears a little bit to capital allocation. In the last few years, you've become more broad-based, EM, India versus a U.S. dominated investment in the past. How do you look at capital allocation priorities in the next 5 years? What would be your top 5 areas for capital allocation?

So first, the core business will get whatever it needs is according to the strategy. So each one of the areas, the spaces that we have discussed have their needs. And we are going to, first, allocate the relevant resources to allow that to happen. By the way, it's not just capital, but also the knowledge, the energy, the team, the talent, et cetera. So all of that is the #1 priority. In addition to that, we are, let's call it, continue to invest in the future emerging businesses for us. Some of these future are many years future, but they are not yet a big growth engine for the company, and this is the biologics, biosimilar that we just discussed. It's about the proprietary business that is primarily now about NCEs, especially in the area of oncology. And it's about the vaccine business that we just discussed. We have a CDMO business that is coming up nicely. So we have certain businesses that can be a very, very nice and appealing growth engines in the future. That will come and serve us primarily in the next horizon of the year. So in the next -- in the current horizon of years, let's say, 3 to 5 years, the current core business, which is primarily based on the generics, branded generics, API will continue to serve us in that respect. Then in addition to that, as we have relatively a good level of financial capacity. So for example, we are going to finish the year with no debt after paying everything for Wockhardt, plus a little bit of surplus of cash. So I think, in that respect, we are very solid in that respect. So we have room for M&As. The primary focus will continue to be India and emerging markets because the business is sticky and the ROC is the highest. So this is still where we want to allocate BD money possible. If possible, we are looking everywhere, but if I can put my preference, this will be my preference.

Thank you so much, sir. Appreciate your insights on the various topic. Thank you for taking time to join us in the session.

Thank you so much, Neha, for having me.

Thank you.