Given the pricing pressure in the core US market and with few opportunities for drugs with limited competition that provide revenue upside, nobody was pencilling in a revival in pharma company earnings in the December quarter.
Expectations are muted and are centred on company-specific themes such as continuation of the recovery in emerging markets and cost rationalization measures in Dr Reddy’s Laboratories Ltd’s case. But as it turns out, the company tripped on both these counts in the December quarter.
The drop in generic product revenues from North America, emerging markets and Europe was in the range of 1-7%. On a sequential basis North America did well, clocking a 12% growth in generic revenues. But that brought no cheer as Europe and India underperformed. Also, the company which had promised cost rationalization against the backdrop of pressure on revenues saw its selling, general and administrative (SG&A) expenses rise 6% from the year-ago quarter. Contrary to the commentary and earlier quarterly trends, SG&A expenses as a percentage of revenues rose—both sequentially and from a year ago.
Still, even then the company managed to report an improvement in gross margin, which widened three percentage points compared to the previous quarter. But as can be seen by the 2% fall in Dr Reddy Laboratories’ share price on Thursday, that didn’t inspire much confidence among investors. Two analysts with different broking firms pointed out that margins were propped up by non-recurring revenue of Rs130 crore, received as part of milestone compensation. Excluding these revenues, the sequential margin improvement doesn’t look that large, say the analysts.
Overall, even as the company reported a respectable 3% growth in revenue and lower-than-expected drop in operating profit, one-off revenues and underperformance in emerging markets made investors wary of the December-quarter results.
The key for Dr Reddy’s Laboratories, as with most pharmaceutical companies, is to obtain approvals for limited competition drugs.
As Emkay Global Financial Services Ltd points out, most large pharma firms now have a low earnings base. If companies resolve their quality issues and gain timely approvals for the plants and new drugs, then earnings can see a meaningful recovery. But much of the recovery will also depend on the changing business environment.
A US Food and Drug Administration proactive in approving new drugs is expected to infuse competition and reduce the long-term commercial potential of complex generics which companies like Dr Reddy’s are focusing on. “Most generic companies are in effect left searching for a long-term viable business model,” Emkay said in a results preview note.
While the business environment is still evolving, the December quarter results for now show that recovery is still a work in progress for Dr Reddy’s Laboratories.