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

Ladies and gentlemen, good day and welcome to the conference call of Eris Life Sciences Limited. We have with us today on the call, Mr. Amit Bakshi, Chairman and Managing Director; and Mr. V Krishnakumar, Executive Director and Chief Operating Officer. [Operator Instructions] Please note that this conference is being recorded. I now hand the conference over to Mr. V Krishnakumar, Executive Director and Chief Operating Officer. Thank you, and over to you, sir.

Thank you, Nirav. I'm Krishnakumar, and I welcome you all to this call to discuss our latest acquisition. Before we get into the specifics of our latest deal, I wish to take a few minutes to recap the ethos of our inorganic strategy. As discussed several times in the past, the key thrust of our inorganic strategy is to leapfrog our presence in attractive therapy areas. We leveraged the Strides acquisition to enter the CNS therapy. We entered the insulin segment through an equity venture with M. J. Biopharm, and we entered the dermatology therapy through a series of deals, starting with Oaknet. We have employed a string of pearls approach in building our dermatology portfolio this year with targeted acquisitions to fill specific portfolio gaps. This approach has helped us maximize business fit and minimize redundancies. We employ a prudent screening approach to every deal that we evaluate in order to ensure evidence of early value creation opportunities, specifically in terms of, number one, strategic fit with our specialty or subtherapy requirements; number two, the presence of arbitrage opportunities by way of fundamentally good businesses, which are suboptimally run; and last but not the least, meeting our financial criteria like gross margin, growth potential, YTM, debt-to-EBITDA ratio and IRR. We approach every deal with an owner manager mindset, wherein we are happy to roll up our sleeves and do the hard work to create value. This discipline has enabled us create value from deals like Strides, Zomelis and Oaknet. Starting with our inception in the year 2007, it took us nearly 13 years to add the first INR 1,000 crores of revenue. However, we are adding the next INR 1,000 crores of revenue in just 4 years by deploying our internal cash flows along with external funding to drive a mix of organic and inorganic growth. We have traveled the journey from INR 200 crores to INR 2,000 crores, while largely preserving our gross margin at the 80% level, and we expect that this will continue to be a way of life at Eris going forward. Coming to the deal specifics. Today, we have announced the acquisition of 9 cosmetic dermatology brands from Dr. Reddy's Laboratories for a consideration of INR 275 crores. This portfolio includes well-known brands such as Hydroheal, ReVibra, Aquaderm, Avarta and Acrofy. The brands are largely in cosmetology segments like anti-acne moisturizers, cleansers, anti-aging, hair health, melasma, et cetera, and have a combined primary sales of INR 50 crore per annum, that is INR 5-0 crore per annum. This deal is in line with our stated intent of building a strong dermatology franchise. We kickstarted this process with the acquisition of Oaknet Healthcare for INR 650 crores in May '22, and we strengthened the franchise with the acquisition of 9 dermatology brands from Glenmark in January of this year for INR 340 crores. While the Glenmark deal helped us strengthen our medical dermatology franchise, the latest deal helps us augment our cosmetic dermatology franchise. Post this deal, Eris will rank #3 in its dermatology covered market with a market share of 7%. Inclusive of this deal, we have invested INR 1,265 crores in acquisitions in this financial year, primarily in building up our dermatology franchise. The aggregate revenue of the business and brands that's acquired is expected to exceed INR 400 crores in the coming financial year, FY '24. This would translate into a YTM of INR 5 lakhs for Oaknet, which is double the YTM of INR 2.5 lakhs it had at the time of acquisition less than a year ago. Further, we know that a YTM of INR 5 lakhs can translate into an EBITDA margin that is very close to our corporate EBITDA margin, which is where we expect Oaknet to be next year. This is a massive uptick from the 10% EBITDA margin, which the Oaknet business had at the time of acquisition. The series of deals done in this financial year has also resulted in a significant diversification of our therapeutic mix. Pre-Oaknet, Eris derived 80% of its revenues from the cardiometabolic and VMN segments. Notwithstanding a 13% growth in these segments, the concentration of the cardiometabolic and VMN segments is now down to 65%. The contribution of our 3 emerging therapies, namely dermatology, CNS and women's health, has increased from 12% to 28% with dermatology having emerged as our fourth largest therapy with a 15% share in overall revenue. We expect this process of therapeutic diversification to continue as we continue to invest in our emerging therapies of insulins, dermatology, CNS and women's health, alongside our flagship cardiometabolic business. This transaction will be financed through borrowings and will achieve financial closure in the next few days. We can now open up for Q&A.

[Operator Instructions] The first question is from the line of Tarang Agrawal from Old Bridge Capital.

A couple of questions for me. One, when you say that you're 7% of the covered market in derma and you're #3 there in, if you could give us a sense in terms of how big is your covered market versus the overall derma market? What do you mean when you're giving this stratification?

Yes. So the concept of covered market is a very standard thing that is followed in our industry. So that is not a new point. It's just a term that is used to denote the particular segments of the market that we play in. So out of the total dermatology therapy, our covered market is around 45% of the total derma therapy. And -- so when we say we are #3 with a 7% market share, we are essentially talking of that 45% footprint, which represents the molecules and the segments that we are presenting.

At an overall level, we are maybe at 10, 11 rank.

Got it. So -- I mean -- like for instance, if I were to understand the diabetes market, right? I mean INR 12,000 crores is solids, about INR 3,000 crore, INR 3,500 crores is insulins, right? And then you have sulfonylureas and you've got everything else within the INR 12,000 crores. So when you say you're 45% of the covered market, are there any specific subcategories within derma that you're covering? Or this is just -- I mean some more details into this would be helpful.

So -- okay. So -- I mean please -- I'm Amit Bakshi this side. Please pardon me. We're still getting more well versed with the market. But as far as I understand -- so there is 2 parts of the market broadly speaking. One is medical dermatology, which is more about the psoriasis, the fungal infections. And the other piece is a little bit tilted on the cosmetology side. So through our first 2 acquisitions, our medical dermatology piece has got very strong. And in that particular context, we were talking about number 3 rank, which is almost 50% of the coverage. Now large markets where we are not covered. So for example, the #1 market in cosmetology is acne and acne care. So our presence in the acne and acne care is still very small. Say hair care, for example. Hair care, again, is a large market, but our presence there is very small. So these are some areas we have a smaller presence. [ Emollients ], for example, one of the largest markets, but we have a very small presence in that [ emollient ] market. So these brands, if you look at these brands, there are still -- it's a pinhole opening for us to really build brands around that 1 brand which we have acquired to make sure that we are able to get a higher market share in these markets where we are not present.

Got it. Got it. That's helpful. Current GCs of the brands that you have acquired, between Glenmark and Dr. Reddy's, would the GCs be similar to Oaknet?

Yes, they are similar to Oaknet. They are in the same vicinity of 78% to 80%.

Okay. And my sense is these products could be manufactured internally, whether in Sikkim or Gujarat, right?

Yes. So we are evaluating that because as of now, most of these products are done by third parties. But given that we have put together a fairly sizable derma basket now, we are evaluating the business case to manufacture these products in our Gujarat plant. So we should have some update on that the next time we meet up.

Sure. And the last, this is going to be 100% debt funded. If so, what's the cost of funding that you're looking at? Will it be fixed or variable?

It is variable in the range of 8% to 8.5%.

Next question is from the line of Prakash from Axis Bank.

Just trying to understand, so we have been fairly aggressive, especially in the derm side and getting the fair share of the market now. So you said that there is a white space of acne within the derm. So you would still be open to looking at more assets?

Yes, Prakash, makes sense. If we get something which will fill the gap. So there are 2 answers to this, Prakash. One is that, now it's time for us to consolidate, right? We have got 3 acquisitions in a year. So we clearly believe that now it's the execution time, the consolidation time. So are we ready to do something big in derma? The answer is a clear no. But if there is something which is useful and still in that range, which gives us comfort, we are still open to that.

Okay. And maybe I missed this, but the MRs, we are just the brand, right? So is it fair to say that the MRs, which came from Oaknet, but they were medical derma and other -- so these are enough MRs or you would need more specialized MR for cosmetic derma marketing?

So we are adding -- what we have done is there's some amount of redistribution of people which we have done. We are adding 1 more division, which will be primarily cosmetology, and we are hiring 50 people from outside, rest 50 of them have been moved from inside from the various divisions. Now between derma and cosmo, what happens, Prakash, it's not such a thick line when you do a presentation in front of a -- promotion in front of a doctor. It's more about training and understanding the product. So I think the team at Oaknet is a very good team at the management level, at the marketing level. And they have had some very good successes in the recent past also. So that I'm not worried from that point of view.

I may just add to that. So the expansion in the field forces to the tune of 40, 50 reps, like Amit mentioned, and the existing field force that handles derma at Oaknet is about 640. So it's really a very incremental expansion that we are looking at. So your earlier point that these brands that have come from Glenmark as well as Reddy's are pure brand deals with very high GCs. So it gives us a very good arbitrage potential in terms of scaling up the YTM of the business and, hence, also the margins of Oaknet.

Understood. And -- so from a margin perspective, it would be fair to understand that there is a lot of headroom. But currently, it will be much below than the company average. And there is a potential to move to the company average is what you are saying?

It is far better than a potential, Prakash. It's pretty much a done deal because this year, we have been saying that our Oaknet EBITDA margin for the year will be around 25%. But once we put all of this together, as I mentioned earlier, our YTM will be INR 5 lakhs per month right from 1st April. So that means that we have clear line of sight on our EBITDA margin, which is in the range of 36% to 38% for next year. It's not a potential, there is clear line of sight.

Yes, correct.

Okay. and this we are saying for the full basket of the Oaknet, the Glenmark and the recent one, Dr. Reddy's?

Yes. We are looking at the entire basket to be north of INR 400 crores in revenue next year with an EBITDA margin in the range that I highlighted to you.

Okay. So 1 more last question, if I may. So we said that we are fairly open to the acne and it makes sense to cover the entire derm market. Just trying to understand white spaces in cardiometabolic solutions...

Sorry, Prakash, say that again?

So acne, you mentioned that clearly you will be invested to complete the derm franchise. But in the cardiometabolic, which has been our key segment, are there new white spaces and would you invested in any?

So Prakash, I can't -- number one, I can't see many where we are sitting at this point of time. And second, historically, it has always been a difficult thing to hunt for. So right now, in our minds, we do not have a sight of getting into something in cardio, diabeto, which is significantly big.

So again, it goes back to the covered market ratio, right?

Yes, sorry.

We missed you, KK.

No, no, that's fine. So I was just saying that our presence in cardiometabolic is pretty expansive. So hence, the probability of finding white spaces is limited to that extent.

The next question is from the line of Tarun Shetty from Haitong Securities.

I just have 1 question. What could be the primary sales growth for this portfolio as in FY '22? And what would be the same year-to-date?

So the primary sale this year was to the tune of INR 50 crores, that's the number. And the CAGR over the last 2 years has been around 8%. And this is despite the fact that these brands were -- despite being very strong brands, they were not promoted. But in our hands, when we look at the kind of focus and go-to-market that we are bringing, creating a new division and provide focus on these brands, we believe that 15% to 20% kind of a growth in the first 3 years is a doable proposition.

Okay. Just a clarification, by INR 50 crores this year, you mean year-to-date FY '23 or FY '22?

Year ending March '23.

The next question is from the line of Aarti Rao from Anand Rathi.

Sir, I just missed out on the brand names that was disclosed. And any top 2 or top 3 brands that crosses over INR 10 or INR 20 crores?

I can hear a slight echo from the management's line. Participants, please stay connected while we re-join the management line back to the call. [Operator Instructions].

Am I audible?

Yes. Perfect. Sir, I had questions regarding the brands that you disclosed. What are those 9 brands? And any brand that probably clocks more than INR 10 crores or INR 20 crores single-handed?

Yes. There are brand names, but the key brands are Acrofy, Aquaderm, Avarta, Hydroheal, ReVibra. So these are some of the key brands. In terms of revenues, there are at least 3 brands in this portfolio, which are north of INR 10 crores, and there are a couple in the INR 20 crore bracket. In terms of leadership positions, 3 of these brands are ranked among the top 3 in their respective segments. And there are another 3 of these brands which are ranked among the top 5 in their respective segments. So 6 out of 9 brands have some kind of a leadership position.

Okay. And my next question is kind of growth. The cosmetic derma segment would be growing on an IPM basis?

So the entire derma segment has a growth of about 10%, 11%. Cosmetic derm is growing slightly faster than the average.

Okay. And do we expect that the drugs that we've acquired -- I mean the brands that we've acquired would grow better than the industry rate?

Yes, that is the expectation. As I mentioned earlier, once we are able to take the brands in and they get settled down within our system, the 15% to 20% growth rate is what we can expect.

The next question is from the line of [ Parag Thakkar from Annual Wealth Management ].

So basically, now what will be your total net debt position?

At the end of March, we'll be at around INR 850 crores of debt.

And our EBITDA will be in the vicinity of what, INR 600 crores?

So from a net debt-to-EBITDA standpoint, we expect we should be at around 1x, 1.5x this year, which will obviously significantly reduce when we look at what numbers we are looking at for next year.

So you -- so any upside cap we can expect that if suppose something else also comes up for acquisition, what kind of upside cap we have in our mind for net debt to EBITDA number?

So we'll be comfortable. See, the banks require you to stick to 3x. So we'll be comfortable holding the 2x mark. That's kind of the internal benchmark that we have for ourselves.

From a shareholder perspective, I would also recommend that only, that not to cross beyond 2x. Also your scalability and your -- the way you have turned around Oaknet and your margins have improved, that tells us about your capability to shore up the margins. But then too, I think net debt to EBITDA of about 2x will be slightly more dangerous. So that is our suggestion also. And the other thing is that in all the brands -- basically, you expect all the entire INR 400 crores to go up to 36%, 38% margin, which you said, right?

That is right.

This is in FY '24 or '25?

'24.

So you're saying INR 140 crore EBITDA, and you will have a debt of INR 800 crores, which you have taken at 8.5%. So INR 70 crore will be the interest cost?

Yes.

Okay. And what growth we should expect from our organic business?

So we can come back to you on that because we'll be meeting you again in 7, 8 weeks when we talk about our results. So we'll give you a completely -- comprehensive picture about the next year.

Okay. Any payout -- any dividend payout kind of in your mind? After all this -- because you will be -- the first priority will be to reduce debt, right?

So as I said, all of this stuff, we'll pick up when we come to talk to you about the year-end results. Right now, we'd like to focus more about dermatology and Oaknet.

[Operator Instructions] The next question is from the line of Prashant Nair from AMBIT Capital.

Just wanted to clarify a couple of things. So firstly, the incremental spend for you on these products would be the 50 MRs and additional sales promotion activity that you would have to do, right? Is that the right way to look at it?

Yes, Prashant. That's right.

Okay. Fair enough. And typically, when you acquire such brands, which have not been core to the sellers, how much do you have to step up intensity related to what you would be normally doing in a product of yours? Is it -- I mean is there any sense you can give which helps us understand what the upfront outlet?

Yes. Prashant, generally, if you ask us, we find it a little convenient to say tail brands and all those things. But when we look at the brand from [ verticality ] point of view and what is the kind of image it has in front of the HCPs, so all these brands which we are talking about and also the Glenmark brands, they really stand out. The Onabet, the Halobate of the world, the Sorvate of the world are really leaders in their own -- in their own therapies. Now what happens, over a period of time, when you have a very large basket, you can't help, but it comes into some kind of a chronological order. So when it comes into a fresh -- when it comes to some fresh hands, the energy all of a sudden increases. And because we -- there are a lot of therapy gaps available in the acquirer. In case of us, the focus and the energy increases very, very rapidly. And just the fact when a brand is promoted as #4 and when it is promoted as #1 or 2, makes a very -- makes a significant difference. So what we will see -- I mean take Oaknet, let's not talk about what will happen to these brands, take Oaknet for instance. So it is just about the energy, the positioning of the brands, and that's how the whole difference is made. So in our plan, we have a very fresh and energetic way to look into these brands in the different therapies. And I believe that energy gives it a [ flip ] for growth.

Okay. And then just 1 more clarification. So KK, when you mentioned the revenue number for some of these brands, so north of INR 10 crores, a couple of which under INR 20 crore bracket, these are at [ AWACS ] level, right? Or are these primary?

Yes. So these are [ AWACS ] number and some of them are a little exaggerated also. What -- I think, off-line, Kruti can tell you exactly what are the brands' size.

[Operator Instructions] The next question is from the line of Niharika from Aequitas Investments.

So considering the cost of acquisition of INR 275 crores and the turnover of around INR 50 crores, so we have given it a value of around upwards of like 5.5 [indiscernible]. So you must have done some market research. So according to you, what justifies this high value which we have given for it? And what revenue potential does this portfolio holds, say, in next 3, 4 years based on your research?

Yes. So that's a nice question. So as we have been alluding to, that cosmetology is a little premium to dermatology, and the growth also, in the last 5 years, has always ebbed the dermatology growth. So cosmetology as a segment is a little more revered than dermatology. That's number one. Then you look at what is the category you're looking at. So say, a product like an Aquaderm, which is like INR 5 crores, INR 7 crores revenue, if I'm not wrong. But the category is [ emollient ]. And it is the perception on that category has been very nice. So we do run this perception analysis among the HCP brand-wise, just to see how the brand is positioned in their head. So because number 1, it is cosmetology; number two, it is ticking the right boxes as far as the therapy is concerned; and historically, cosmetology has been a little more revered and growth has also been better than dermatology, that put together makes that premium rich growth and all.

Okay. And any revenue potential that you must have kind of assessed in, say, next 4 years, 5 years of on a long-term basis that this nice brands can go up to this level from INR 50 crores to, say, some number?

So look, 15% to 20% growth in these products, just because they are early brands, the sizes are all -- and average size is between INR 8 -- INR 5 crores to INR 9 crores. Therefore, we find the headroom is quite good. So we assume a 15% to 20% growth over the next 4 years.

Next question is from the line of Harshal Patil from Mirae Asset.

Sir, just had 1 question to ask you. Basically, this was with respect to the margins for Oaknet. Sir, if we see the quarterly Q3 margins as of December quarter, I guess Oaknet was at around 27%. And right now, we are expecting about 25% for FY '24. So sir, am I missing something out here?

Yes. So I mentioned that 25% would be the margin for this year. That is FY '23 full year approximately. The margin for '24 will be in the range of 36% to 38%.

Okay. And sir, the levers would effectively be the ramp up in the portfolio of derma, that's Glenmark plus Oaknet plus Dr. Reddy's portfolio?

Yes. So leverage -- ramp-up will always be a leverage. But what is important here, when you get brands and you make them sit on the same people, that is where the whole -- the productivity thing kicks in. And as a thumb rule lever, if you are in the vicinity of 78%, 80% gross margins and are hitting a INR 5 lakh -- close to INR 5 lakh kind of a YTM, then these kind of margins -- so when -- when we are giving you these numbers, we have really not incorporated a substantial growth in the whole Oaknet system. We are giving you a very nominal kind of a growth because we have to just get things together. But it's just a function of a INR 5 lakh productivity and a huge gross margin between 78% to 80%. So largely if these 2 things are there, the EBITDA margins will fall in between that 36% to 40%.

Next question is from the line of Shalabh Agarwal from Snowball Capital. [Operator Instructions] Due to no response, we move to the next participant. Next follow-up question is from the line of Tarang Agrawal from Old Bridge Capital.

Just wanted to check, you mentioned that you're #3 in the covered market for derma. Would the top 2 players be the same players who are the leaders in overall derma therapy for this covered market as well?

GSK, in this particular case, for the covered market, yes, they are ahead of us.

Next question is from the line of Ayush Vimal from Clearview Capital.

I've been a key part of a strategy to shore up gross margins to ultimately make these products in-house -- these acquired brands in-house. Just wanted to check what is the maximum turnover that we can generate out of the INR 300 crore-odd gross block that we have currently and whether there will be an imminent need for creating new capacity going forward if we were to ensure these products?

So I'll answer those 2 questions one by one. So the potential for fixed asset turnover in our industry is very high, like we are seeing a fixed asset turnover of more than 10x for our Sikkim plant. So we expect you should see at least that, if not more, for the new facility. In terms of bringing the derma operations in-house, that is actively being evaluated. It will require -- so at present, our second facility is configured for oral solid dose and injectables, not for derma. So if we do bring these products in-house, there will be some incremental investment, which we can quantify as soon as we make that decision. But your point is right that there will definitely be an arbitrage in terms of improvement in gross margin if they are brought in-house.

Yes. And am I wrong in saying that we will not need any land and building because the blocks are already -- we already have blocks in place. So it will all be plant and machinery.

Yes. So it won't be civil, no utilities.

Any time line that we have in mind to build these brands in-house?

That's being evaluated right now. We haven't crystallized on anything, but the next time we have a chat, I'm sure we'll have some kind of an update.

Got it. And including these brands, what is the percentage of products that are manufactured through third party, if I can get that number from you?

Was the question for the derma portfolio or for company as a whole?

Company as a whole.

Third-party percentage is 15% to 20%.

Ladies and gentlemen, we will take that as the last question. On behalf of Eris Lifesciences, that concludes this conference. Thank you for joining us. You may now disconnect your lines. Thank you.