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

Ladies and gentlemen, good day, and welcome to Dr. Reddy's Laboratories Limited Q3 FY '23 Earnings Conference Call. [Operator Instructions] Please note that this conference is being recorded. I now hand the conference over to Ms. Richa Periwal. Thank you, and over to you, ma'am.

Thank you. A very good morning, and good evening to all of you, and thank you for joining us today for the Dr. Reddy's Earnings Conference Call for the quarter ended December 31, 2022. Earlier during the day, we have released our results and the same are also posted on our website. This call is being recorded, and the playback and transcript shall be made available on our website soon. All the discussion and analysis of this call will be based on the IFRS consolidated financial statements. To discuss the business performance and outlook, we have the leadership team of Dr. Reddy's comprising Mr. Erez Israeli, our CEO; Mr. Parag Agarwal, our CFO; and the Investor Relations team. Please note that today's call is a copyrighted material of Dr. Reddy's and cannot be rebroadcasted or attributed in press or media outlets without the company's expressed written consent. Before I proceed with the call, I would like to remind everyone that the safe harbor contained in today's press release also pertains to this conference call. Now, I hand over the call to Mr. Parag Agarwal. Over to you, Parag.

Thank you, Richa, and greetings to all, and wishing you all a very happy New Year. I'm pleased to take you through our financial performance for the quarter. For this section, all the amounts are translated into U.S. dollars at a convenient translation rate of INR 82.72, which is the rate as of December 30, 2022. This is yet another quarter with a strong all-round financial performance expected in highest ever sales and profits and strong free cash flow. Consolidated revenue for the quarter stood at INR 6,770 crores, that is USD 818 million and grew by 27% year-on-year basis and by 7% on a sequential quarter basis. The performance was supported by healthy growth across our businesses with contributions from both base business and new product launches. Consolidated gross profit margin for this quarter stood at 59.2%, an increase of 545 basis points over previous year and 15 basis points sequentially. On a year-on-year basis, the gross margins were mainly aided by an increase in contribution from new products and favorable product mix. Gross margin for the global generics and the PSAI business were at 64.6% and 18.2%, respectively for the quarter. In line with our expectations, PSAI gross margins have rebounded compared to the last quarter. The SG&A spend for the quarter is INR 1,798 crores, that is USD 217 million, an increase of 17% year-on-year and 9% quarter-on-quarter. The expense in the 10 quarters reflect an increase in investments, certain one-off expenses and an impact of the ForEx rate. As a percentage to sales, our SG&A has been at 26.6%, which is lower by 240 basis points year-on-year and marginally higher by 30 basis points sequentially. The R&D spend for the quarter is INR 482 crores, that is USD 58 million and is at 7.1% of sales. We have been making good progress on our R&D pipeline in line with our business strategy. We continue to drive productivity across our businesses while also making investments to strengthen the product pipeline and capability development in marketing, digitalization and people, including for the Horizon 2 initiatives. The net finance expense for the quarter is INR 14 crores, that is USD 2 million. The EBITDA for the quarter is INR 1,966 crores, that is USD 238 million, and the EBITDA margin is strong at 29%. Our profit before tax stood at INR 1,635 crores, that is USD 198 million, which is a growth of 68% year-on-year and a growth of 1% quarter-on-quarter. Effective tax rate for the quarter has been at 23.7%. We expect our normal ETR to be in the range of 25% to 26%. Profit after tax for the quarter stood at INR 1,247 crores, that is USD 151 million. Reported EPS for the quarter is INR 74.95. Operating working capital decreased by INR 490 crores, which is USD 59 million, against that on September 30, 2022. The decrease is majorly due to higher collection of receivables and some increase in sales. Our capital investment during the quarter stood at INR 292 crores, which is USD 35 million. We generated healthy free cash flow during the quarter of INR 1,975 crores, which is USD 239 million. Consequently, we had a net cash surplus of INR 3,401 crores, that is USD 411 million as of the end of the quarter. As of 31st December 2022, foreign currency cash flow hedges in the form of derivatives for the U.S. dollar are approximately USD 351 million, largely hedged around the range of INR 80.3 to INR 83.3 to the dollar, RUB 2,975 million at the rate of INR 0.9661 to the Ruble, AUD 1.8 million at the rate of INR 56.20 to Australian dollar, and South African rand 34 million at the rate of INR 4.81 to South African rand maturing in the next 12 months. With this, I now request Erez to take us through the key business highlights.

Thank you, Parag. Good morning, and good evening to everyone. I hope you and your loved ones are keeping well. I'm glad to report that we continued the strong financial performance in the current quarter as well as with record sales, profit and cash flow generation. We made good progress in our productivity journey, which allow us to remain competitive and grow in our markets. We have been able to identify several new business opportunities, which refer to our Horizon 2 business and have started building this. We have also made good progress against most of our ESG goals. Let me share with you some of the key highlights of the current quarter. One, strong revenue growth driven by continued production in U.S. and Russia markets; second, high cash generation leading to net cash surplus of more than $400 million at the end of the quarter; three, significant progress made for biosimilars, completion Phase III clinical study for rituximab and completion of Phase I clinical studies for tocilizumab. Let me cover a business-wise key highlights in a bit more details. Please note that all the references to the number in these sections are in representative local currencies. Our North America generics business recorded sales of $375 million for the quarter, with a strong growth of 51% year-over-year and 7% on sequential basis. Sequentially the sales continued to grow in the U.S. market with a positive traction seen in both base business and recent launches, including Sorafenib [indiscernible] hydrochloride and lenalidomide capsules. While contribution from lenalidomide capsules may fluctuate from quarter-to-quarter, we expect it to remain meaningful over the next few quarters. In this quarter, we launched 5 new products and expect the launch momentum to continue during balance of the year. Our Europe business recorded sales of EUR 51 million this quarter with a year-on-year growth of 8% and sequential quarter decline of 2%. During the quarter, we launched 11 new products across various countries within Europe. We expect to continue with the growth momentum in the rest of FY'23. Our emerging market business recorded sales of INR 1,310 crores with a year-on-year growth of 14% and sequential growth of 7%. Within the emerging market segment, the Russia business grew by 29% on a year-to-year basis and 8% on quarter-to-quarter basis in constant currency. This strong growth was supported by higher sales of biosimilar products in Russia. During the quarter, we launched 29 products across various countries of the emerging markets. We expect this business to continue the growth momentum during the balance of the year. Our India business recorded sales of INR 1,127 crores with a year-over-year growth of 10% and sequential decline of 2%. During the quarter, we launched 2 new products in the Indian markets. We are creating several growth engine for India business for Horizon 1 and Horizon 2, which includes ramping up internal portfolio, collaborations, innovation and inorganic opportunities. Our PCAI business recorded sales of $95 million with a year-over-year decline of 2%, however, a strong growth of 18% on a sequential quarter basis, contributed by an improvement of the volume pickup. This business started to show signs of recovery, and we expect this momentum to continue in the coming quarters as well. We are progressing well on our pipeline products. The number of filings in several of our key markets have been improving. The ANDA and drug master filings are expected to significantly improve during Q4. We are evaluating several inorganic opportunities across businesses in line with our strategy. We believe all of this will lead to several growth opportunity for us, both in the short-term as well as in the long-term. I am confident that we'll be able to continue the growth momentum supported by our stronger cash position, focused management team and robust governance and processes. Within this, I would like to open the floor for questions-and-answers.

[Operator Instructions] The first question is from the line of Kunal Dhamesha from Macquarie Group.

Congratulations for the great set of numbers. So the first question on REVLIMID. I think I missed your comment where you said the REVLIMID revenue could kind of fluctuate on a quarter-to-quarter basis. But is there any kind of outlook that you are providing for, let's say, quarter 4 and FY '24 -- in terms of the quantum, relative quantum vis-a-vis quarter 2 and quarter 3 what we have seen.

So we cannot share as it's part of the agreements that we have. But that's what I said, it's -- what I will determine the size of the opportunity is, of course, the timing of the orders that will come from the customers. That may vary from a month-to-month or quarter-to-quarter. But overall, it's -- the product will continue to be meaningfully contributing to our business. And we are very confident about.

Okay. And is it kind of fair enough to assume that the contribution is expected to increase next year?

We cannot share guidance in this respect, because it's part of the agreement. That's why I'm sharing what I'm able to share at this stage.

Sure. And second question on -- while we have shared that our capital deployment priority is kind of India followed by the branded markets and likewise. But I think we are generating significant cash flow and we have not seen any activity on that front. So is there a basic time line which you are looking at to deploy this cash or else we are considering any other option to about returning this well to shareholders?

We are engaging in the multiple business opportunities and naturally we'll be able to share that when we'll sign the deals. Like we discussed in the past, we knew that this is coming, and we knew the type of capital that we are going to create. So for us, it's well within our plans and our strategic plans. The priorities will continue to be similar to what we have discussed in the past. We want to engage it in this development, which is not a shopping spree of big deals, but rather complementary deals that will enable our strategy and create capability of rents that we don't have or areas in which we can create more meaningful contribution to our both all stakeholders, customers, shareholders, et cetera. The second is to continue to invest in both Horizon 1 and Horizon 2 in CapEx and R&D. That's the use of the money. We believe that we will have a good use for it.

Next question is from the line of Damayanti Kerai from HSBC.

My question is on India business. So although on a year-on basis, you have seen good growth, healthy growth, but sequentially, it has declined. And what we have seen in some market database is that properties growth has been lagging against the broader market growth. So how should we see growth outlook for your India fees given it's the most important segment for you? And what will be key growth drivers from here on?

The main growth will come from investment in differentiated products and the specialty products and collaborations that we are working. So we are planning to introduce a lot of innovation in India, and we are building it. In addition to that, we will continue to focus on the brands that we believe can contribute in short terms but much more in the long term. And we will continue also to invest in the capabilities to market it in the most productive manner using all the relevant digital tools and the ability to maximize the return on the investment. We are going to see also in India continued divestitures of the brands that we are not planning to invest behind. If we believe that the returns that will come from those divestitures will be more than what we will get if we continue to market it. So in that respect, we are well within our strategy. And maybe the results here and there will fluctuate in terms of brand, but overall I'm very confident that will be top 5 as per the target that we shared with you long back.

Sure. And in the acquired Wockhardt portfolio, which you have done some time back, are the regions in line with your initial expectations? Or do you think you have further headroom to see better sales for some of the top brands.

The Wockhardt products sales are now serving us very well. I'm very happy with these acquisitions. It's already exceed our expectations.

And my last question is on Russia business. So this has been very strong quarter, which you mentioned there were biosimilars, which contributed. So should we assume this to be sustainable sales? Or the sales driven by some onetime pickup and we might see moderation from here on?

Russia will continue to do -- to be strong for us. Quarter-wise, it will fluctuate. This quarter, it's a timing of the bids with the government on biosimilars, for example. So unlikely that we will see that in the other quarter. So it will fluctuate, but overall, we are going to see in the local currency growth. And as related to the protection of the ruble, I think we have a very -- likely for this year, we have a very good protection on the ruble itself. So we are -- I'm optimistic from -- even with the scenarios that there will be a significant devaluation of ruble.

Next question is from the line of Surya Patra from PhillipCapital.

Thanks for the greater of numbers. Just on the REVLIMID side, if you could share something more on the kind of a visibility in terms of like it seems that first 2 quarters -- in the last 2 quarters, whatever number that we would have generated, it seems that we have already achieved around 5% or mid-single-digit kind of volume hit in the product opportunity. So considering that, is it fair to think that fourth quarter and first quarter possibly could be a relatively lower number that we could see from REVLIMID.

I cannot share any numbers about the quarter. So…

Okay. But sir, could you give some sense about, let's say, in terms of the volumes, whatever that is fixed for the first year, how different the volume share number would be for second year? Was indicated…

Again, it's not because I would love to share but I can't. We have an agreement, and I have to honor the agreement. So please bear with me on that.

Okay. Sure, sir. Then sir, the extended question relating to this that, see the cash flow generation, what we are witnessing. So considering that, so the new term priorities, could you share the near-term priorities that you would be having? Because what I have seen that you have already indicated that you are likely to be -- or you are likely to remain active in terms of inorganic growth, as well as the R&D spend also, right, if I see, it has just moved on along with the kind of a ramp up in the revenues. So considering these 2 things, what priorities that would be there for us in the next 12 to 15 months or 18 months period going ahead?

So as we discussed in the past, our priority is a productivity in the short term. So it needs to grow what we call Horizon 1, which is meaning the current business that we have as including investment in those productivity investment in our portfolio, in the ability to get some of those complex generic faster to the market, some of those biosimilars faster to the market as well in Horizon 2, building those new businesses that will give us the growth in the future. As we shared in the past, we assumed that we will be able to generate enough cash and enough profit to finance for those activities. And so far, it is going well for us. The extra cash that we will have, we will use for business development and for investment in capabilities in the business, especially digital organization, automation and artificial intelligence. And in line of what we have discussed. So I'd say the old guidance remain the same. We are comfortable on a long-term basis with the 25% EBITDA and 25%, I will see double-digit growth and no debt. This continues to be the guidance that from time to time, we'll be above it like this year. From time to time, we'll be below it, like some couple of quarters ago. But overall, I think it allow us to both to be very healthy company and to grow very, very well. And we have a potential upside even to exceed these numbers. But so far, we are very much into that. That makes up for the quarter-to-quarter, but if you see our record for the last few years, we are very much where we said we are going to be.

Sure, sir. So then the revenue -- U.S. revenue, excluding REVLIMID, if you consider, we have seen this year as a kind of a -- we, although we maintained the revenue run rate, excluding REVLIMID. But there were challenges and a couple of our key products also replaced competition from others, largely from Indian players only. So for this revenue, please, could you give some sense that, okay, next year, what is the visibility that you are having? Are you likely to see the sustained competition and all that impacting the business or some sense about growth that if you can indicate for the U.S. business, excluding REVLIMID?

Next, in FY '24, we are planning to launch at least 30 products, give or take. And we are planning to continue the growth that we saw in the last couple of years. So we indicated that we believe that a baseline of 6%, not 6%, single-digit growth, 6% was the past, single-digit growth will likely to happen and maybe more than that. And from time-to-time, we'll have a product or products that will create much better growth than that like happened to us in the last couple of months. And those products at a certain point time also will go down with erosion [indiscernible]. So overall, the trend is growth. In addition to that, we believe that once Horizon 2 will kick in, also the U.S. will grow in double-digit, but this is in the later stage towards 5, 6, 7 years from now. So now it may fluctuate because of price erosion, it comes to predict that market share it has to predict. So unfortunately, I cannot -- I don't know what will be quarter-on-quarter, but absolutely, we are planning to grow in the United states.

Okay. And is it fair to believe sir, the next year we will see a kind of a meaningful ramp-up in the kind of a spend towards Horizon 2 plans, growth plans versus current year?

We don't like to ramp up spend. We are planning to spend in accordance -- in a very disciplined manner in accordance to our growth. At the time, we indicated that we are going to have more expenses both in the SG&A as well as the R&D. But within the rates of profitability that I mentioned in the past, so we will be able with our growth and our cash to finance the investment, it will not be extra and…

[Operator Instructions] Next question is from the line of Prakash Agarwal from Axis Capital.

Just wanted to understand what is the industry level question. So we've been seeing a lot of U.S. FDA issues going to the next level. And we've been hearing that there is a volume distribution that is happening to the large Indian and global players in the U.S. generic side. Are we seeing that happening to us also? We are getting some volumes for our base business. Would that be correct understanding?

We do have growth in volumes. I cannot attribute necessarily for that. The growth at the case we are facing is from activities that we initiated primarily. Naturally, we are watching carefully, all the results of all the inspections that are happening in India and outside of India. So far, for us, knock on wood, all of our banks are operating and in full compliance.

Okay. And with that kind of volume gain, et cetera, do you think there is some improvement in pricing on base business? Or it still remains mid- to high single digit for the base portfolio?

I'm not aware of any, let's say, special phenomenon that can indicate both on price or qualities, as related to that.

It means similar range of…

Maybe marginal, maybe.

Okay. Fair enough. So would it be fair to say that the incremental growth, you had some approvals and launches for sure. But with the price erosion, it nets off and the incremental sales momentum is coming from this product itself?

I believe that our growth is coming because we are giving better service to our customers and they appreciate it.

Okay. And last one on the capital allocation. We have seen some companies being successful in late stage innovator led programs. Are we thinking about it? Or in the past, we had done 505(b)(2), and then we move to self-sustaining and selling those assets. So what is the plan for both these? I mean if there is any plan on both these strategies?

We are not planning to come back to the 505(b)(2). We worked hard to get out. Horizon 2 contains activities that are differentiated by design. So we are talking about 11 spaces in India and a couple of spaces outside of India and large market Europe, as well as the United States. We do have NCE as part of our origin discovery, especially in the area of cancer. We do have activities in Celgene therapy in therapeutic management, in OTC, in nutraceuticals as well as in the other innovation of go-to-market. This is part of the Horizon 2 that we shared, but not 505(b)(2).

Next question is from the line of Sameer Baisiwala from Morgan Stanley.

First question is on government grant. It looks like in 3Q, you did INR 43 crores in first half, some INR 240 crores odd. So I guess your product mix is not changing that much. So what's driving this?

So the grant, this -- obviously, we filed the applications as per the government scheme, Sameer, and it depends on the eligibility of the products and the sales that we are making. So depending on the underlying numbers, the grant is recognized. So it's obviously something that will continue, but we'll fluctuate from 1 quarter to another.

Okay. So, fair enough. I get that. But is the product mix changed so much? The products which were eligible, you didn't do those sales in 3…

Yes, product mix changes. And the sales level of various products also changes. So that return is the incentive.

Okay. Cool. And the second question is on biosimilars. You clearly have focused on that. But if I look at your pipeline, I mean, first of all, good job on Rituxan for Phase III. But to succeed in this market, you need good 5, 10 products, a fairly vibrant pipeline, 7 products in Phase III type of a situation. So can you talk a bit about it, how will you make a mark in this space?

If you recall, we decided the time to skip the products that will be with the patent expiration until 2027, because we felt that will be late to the market. And we have a pretty robust portfolio for the patent if that is after the even larger number of what you just said. We kept rituximab as it was already there, we are already selling it in 27 countries. And by having the USFDA approval, this will allow us to sell it in many more countries, and we have also agreement with a third party in the U.S. market. Rituximab also will bring the USFDA, and we will be able to prove the relevant side from GMP point of view. So to your question, we are committed. We are committed to even larger number of molecules than that. And over time, we are going to see it. And in accordance to the relevant net that we need to launch the product and -- but we're absolutely going to play biosimilars to be a significant player, especially in emerging markets.

Okay. Got it. And one -- final one is on icosapent. It's been sometime that we are stable at 14%, 15% market share. So what's the outlook on this?

We'll continue to try this to gain as much market share as possible. It fluctuate according to decisions of customers.

It's not about supply chain or raw material issue?

No, no, no issues. This was sold, I think a year ago.

[Operator Instructions] Next question is from the line of Kunal Dhamesha from Macquarie Group.

So I think on the biosimilar products that we are -- we have got a good trial data, et cetera. Do we have the existing capacity, which can support, let's say, clear market share in this product? Or would we need to invest more? And if yes, would it be the same facility where you would seek expansion, or it would be a greenfield facility?

We are investing in capacity for the last 5 years and continue to invest, and likely to see our facilities invest fully and are growing every year. Yes, we have enough capacity to capture market share globally.

And what would be our current biologics capacity, reacted capacity in total in terms of kiloliters? And the gross block related to it?

I don't remember the kiloliters, but we can produce let's say, many, many hundreds of kilos we can…

And in terms of our cost structure, would you have benchmarked our cost of production versus, let's say, Korean and Chinese player? And where we stand versus them?

We believe that we are well competitive in terms of cost structure and part of it is because the technology we are using, part of it is the accretion that we have on the product and part of it is the fact that we are in India and leveraging the economy of India.

Next question is from the line of Prashant Nair from AMBIT Capital.

My question is on the PSAI business. So we've seen the recoveries here. I mean is it fair to assume that the disruption in this business is behind us and there is -- this will continue to normalize as we go forward. And the second question is on the gross margin side again. This used to be the mid-20, mid-20% gross margin business in the past. Can you still get to those levels? Or would it settle a bit lower?

I believe that we should go there. And we are in the right direction to be there. And I also believe that the challenges that we faced in the last 18 months or so are behind us. And like I mentioned, we do see a very good signs of recovery. There is still room for improvement also on that side, which I believe that we will achieve.

Next question is from the line of Saion Mukherjee from Nomura.

Erez, can you update us on China filing and how the business is doing? And when do you expect meaningful traction in revenues?

So we continue with the process. It's going well. Amit, can help me, but I think we also bought 14 or 15 products...

Yes, every year now, Saion, we have started filing more than double-digit -- double-digit filings have started. As we speak, we have about 20 filings pending approval. And in the next few years, so going by this run rate obviously, there will be 40, 55 being over the next 3, 4 years. So typically, after filing, it takes 18 to 24 months for a product to get approved. So last year, we got like approval for 4 products. This year, we expect similar run rate and going forward, even it to become better and better. So all I think statistics are working as we have expected, and the sales also should start picking up faster. So we are already growing in double-digits, but that can start growing faster, maybe somewhere second half of '24, '25 onwards.