Dr. Reddy’s Laboratories Limited (NYSE:RDY) Q2 2023 Earnings Conference Call October 28, 2022 9:00 AM ET
Company Participants
Amit Agarwal – Head of Investor Relations & Director of Finance
Parag Agarwal – Chief Financial Officer
Erez Israeli – Chief Executive Officer
Conference Call Participants
Tarang Agarwal – Old Bridge Capital
Prakash Agarwal – Axis Capital
Kunal Dhamesha – Macquarie Capital
Damayanti Kerai – HSBC
Surya Patra – Philip Capital
Operator
Ladies and gentlemen, good day, and welcome to Q2 FY ’23 Earnings Conference Call of Dr. Reddy’s Laboratories Limited. As a reminder, all participant lines will be in the listen-only mode, and there will be an opportunity for you to ask questions after the presentation concludes. [Operator Instructions] Please note that this conference is being recorded.
I now hand the conference over to Mr. Amit Agarwal. Thank you, and over to you, sir.
Amit Agarwal
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 September 30, 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 operative 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. Redis and cannot be rebatcasted or attributed in press or media outlets without the company’s express 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, sir.
Parag Agarwal
Thank you, Amit, and greetings to everyone for the current festive season. This quarter, we had strong financial performance with higher server sales, PBT and EBITDA in our quarter. The performance has been supported by the launch of lenalidomide capsules in the U.S. and rebound of Russia performance over last quarter.
Let me take you through the details for the quarter. For this section, all the amounts are translated into U.S. dollar at a continuous translation rate of INR81.37, which is the rate as of September 30, 2022. Consolidated revenue for the quarter stood at INR6,306 crores, that is US$775 million and grew by 9% year-on-year basis and by 21% on a sequential quarter basis. In the same quarter of last year, we had high coverage product sales, adjusted for which we have grown in high teens in this quarter. Consolidated gross profit margin for this quarter stood at 69.1%, an increase of 55 basis points over previous year and 920 basis points sequentially. The gross margins were mainly aided by favorable product mix and production linked incentive recognition. However, it was partially offset by a provision made on COVID product inventory as the sales on these products have reduced significantly. Gross margin for the global generics and PSAI businesses were at 65.4% and 3.6%, respectively, for the quarter.
PSAI gross margins were primarily impacted due to inventory provision on Covis products and adverse leverage on manufacturing overhead on a lower sales base. We expect it to improve in the coming quarters. The SG&A spend for the quarter is INR1,656 crores, that is US$204 million, an increase of 4% year-on-year and 7% quarter-on-quarter, which is in line with business growth. As a percentage of sales, our SG&A has been at 26.3%, which is lower by 140 basis points year-on-year and 340 basis points sequentially. The R&D spend for the quarter is INR487 crores, that is US$60 million and is at 7.7% of sales. We have been making good progress on our R&D pipeline in line with our business strategy.
Further, while we continue to drive productivity, we have been investing it back to strengthen our development pipeline, building marketing capability and digitalization. The net finance expense for the quarter is INR16 crores, that is US$2 million. We have been able to manage well the risk arising from the ForEx fluctuations in the current volatile environment. The EBITDA for the quarter is INR1,932 crores, that is US$37 million, and the EBITDA margin was strong at 30.6%. Our profit before tax stood at INR1,611 crores. That is US$198 million, which is a growth of 27% year-on-year and a growth of 10% quarter-on-quarter. Effective tax rate for the quarter has been at 30.9% due to the FX effects arising from jurisdictional rates. We expect our normal ETR to be in the range of 25% to 26%. Profit after tax for the quarter stood at INR1,113 crores, that is US$137 million.
Reported EPS for the quarter is INR66.89. Operating working capital increased by INR322 crores, which is US$40 million against that on June 30, 2022. Our working capital base is due by 15 days due to optimization of inventory across our businesses and factoring of receivables in Russia. Our capital investment during the quarter stood at INR251 crores, which is US$31 million. The free cash flow during this quarter was INR580 crores, which is $71 million. Consequently, we now have a net cash surplus of INR1,373 crores in that is US$159 million as on September 30, 2022. Foreign currency cash flow hedges in the form of derivatives to the U.S. dollar are approximately US$402 million, largely held around the range of INR78.8 to 81.7% to the dollar maturing in the next 12 months, 4,320 million at the rate of INR0.99 2.4 million at a rate of AD56.04 and South African brand $67 million at the rate of INR4.82 to South Africa and maturing in the next 6 months.
With this, I now request Iris to take you through the key business highlights.
Erez Israeli
Thank you, Parag. Good morning, and good evening to everyone. I hope you and your large ones are keeping welcome. I am pleased to take you through the current quarter performance, which is marked by record sales, EBITDA and ROCE.
In the last few years, we have built a well-diversified business model, which allows us to have multiple growth drivers and reduce the risk of being dependent on a sign market or event. We believe that the current environment of geopolitical and economic uncertainties, inflationary pressure or and ForEx volatility here, our strategy is allowing us to grow. While there may be some fluctuation quarter-on-quarter, we focus on building portfolio pipeline across markets, driving productivity, investing for innovation and taking forward our ESG agenda. We believe that our strategy, along with a net cash position will enable us to drive sustainable growth in line with our aspirations.
Let me share you some of the key highlights of the current quarter. One successful commercialization of volume limited launch of Minalidumide capsuled in the U.S. market. rebound of Russia sales after this went to rechannel stock normalization in last quarter. USFBpproval of Pitestream received by our partner, improving visibility and commercialization of our products. Our largest manufacturing facility in Hyderabad internally referred as FTI, a joined Global Lighthouse network for the economic call. Now let me take you through the key business highlights for the current quarter. Please note that all references to the numbers in this section are in respective local currencies.
Our North America Generics business recorded sales of $351 million for the quarter, with a strong growth of 38% year-over-year and 53% on a sequential basis. This was largely attributed to the new product launch contribution including the volume limited launch of lenalidomide capsules in the in the U.S. market. While we wouldn’t be able to mention specific sales volume or value arising from [indiscernible], we expect these products will continue to contribute meaningfully over the next few quarters as well. The price erosion for the base business has been within the moment transcend over the last 3 quarters — in this quarter, we launched 7 products and expect us momentum to continue during the balance of the.
Our Europe business recorded sales of $52 million this quarter with a year-to-year growth of 10% and sequential quarter growth of 4%. During the quarter, we launched 10 new products across various countries within Europe. We expect to continue with the growth momentum in the rest of FY ’22. Our emerging market business recorded sales of INR1,225 crores with a year-on-year decline of 6%. However, a sequential growth a quarter growth of 6%. The year-to-endecline was due to a higher base effect as we had COVID product sales in Q2 of FY ’22.
Adjusted for this COVID contribution, we have grown — within the emerging market segment, the Russia business declined by 2% on a year-over-year basis and grew by 84% on a quarter-to-quarter basis in constant currency. The sales for Russia has reverted to normal levels after the channel inventory stocking and normalized in the last quarter. During the quarter, we launched 31 new products across various countries of emerging markets. We expect this business to continue for the growth momentum in B.
Our India business recorded INR1,150 crores with a year growth of 1% and a sequential decline of 14%. Adjusted for the covid product sales during Q2 FY ’22, and the brand divestment income in Q1 of FY ’20, we have grown in mid-teens year-over-year and mid-single digits sequentially. During the quarter, we launched 2 new products in a market. As per a tube report of June 2022, our MAT rank in value terms is at number 10. We will continue to reset our portfolio in India business with focus of growing big brand acquisitions, partnerships for focus therapy, while divesting noncore brands. Our PCI business recorded sales of $81 million with a over-year decline of 29% and sequential decline of 12%.
Adjusted for the COVID product sales in Q2 of FY ’22, the business has declined in single digits over last year. The decline has been due to lower volume pickup by customers for some of the key products. We expect sales improvement over the next couple of quarters with increasing volume pick up and launch of new products. We have been progressing well in our journey of building a portfolio of complex and differentiated products, biosimilar and NC pipeline. We have also made a good progress to identify a list of innovation moves to our branded markets.
We continue to actively look for investment opportunities for businesses in line with our strategy. We believe that even in the current uncertain environment, there are multiple opportunities to grow our business, and we are committed to pursue this in line with our strategy.
With this, I would like to open the floor for questions and answers.
Question-and-Answer Session
Operator
Thank you very much. We will now begin the question-and-answer session. [Operator Instructions] We have our first question from the line of Tarang Agarwal from Old Bridge Capital.
Tarang Agarwal
Three questions from my side. The first question is on Lenalidomide. Just wanted to get a sense that where the volumes bunched in the current quarter as per the agreement with the innovator? Or should we expect the volumes committed by Dr. Nedis in the current quarter to probably continue as we proceed. So that’s number one. Number two, if I look at the cash flow statement for the business, there’s roughly about INR600 crores that’s been spent on intangibles. So I wanted to understand what is the nature of this? Is it a purchase of ANDAs or something else? And the third question is on the PSAI business. I believe the gross margins for this business have been declining continuously over the last 1 year, and they came to a low of about 3.5% this quarter. So if you could just explain what’s happening there? Is this supposed to move up going forward? Or how should we look at it? And what is driving this decline, not specifically for this quarter, but over the last 3, 4 quarters?
Erez Israeli
Thank you. I will take the first and the third, and Parag will take the second question. On the first, it’s absolutely within the scope of the settlement we had with the innovator.
Operator
Ladies and gentlemen, we’ve lost the connection of request you to stay connected. Yes, please go ahead.
Erez Israeli
Yes. Do me now, sir?
Parag Agarwal
Were there…
Tarang Agarwal
Yes, if I’m — I couldn’t…
Erez Israeli
Our line growth, sorry. So on the first question on Milan. — the quantities are within the scope of the agreement that we had with the innovator, and we will continue to sell the product also in the next coming quarters. On the third question, indeed, the volumes of the API, the volume of the APIs, especially on some of the oil products went down. And this is the main reason of also the gross margin. This is a very much a fixed cost type of an industry. So what we see that likely the die will go up. And naturally, with that also the margins will go up. Now over time, strategically, we see growth lever in the PCI in general in all 4 levers. One is the data itself, primarily driven by certain launches of Croda in which we will sell commercial quantities for launches that will happen this year, next year and day after for those that are, including e-mails. The second is that our IMMO business, CDMO business, ATS, which is also a problem under this segment is going to grow, and we do see better traction in that direction. And number three, our activities that what we call the indirect business-to-business sales, especially in the Middle East Asia and Japan.
We also see a likelihood of increase. And that was not least, we do have certain pending deals with the organizations like the Gates organization that are supporting mid- and low tiers in terms of economic countries, and we have some interesting projects ahead. So overall, we can guide that we believe that for these segments will grow also in the future. a, maybe the second question.
Parag Agarwal
Yes. Saran, the second question, I will take the — in the cash flow, the intangible amount that you see is towards the acquisitions that we have announced publicly also in the last couple of quarters. This includes Sigma from Novartis, also the Eaton portfolio under development and lower small acquisition to pay back. So it’s basically towards the acquisition.
Erez Israeli
Thank you.
Operator
We have our next question from the line of Prakash Agarwal from Axis Capital. Please go ahead with your question.
Prakash Agarwal
Yes.
Operator
We are not able to hear you. Your voice is breaking, sir.
Prakash Agarwal
Am I horrible now?
Operator
Yes, please go ahead.
Prakash Agarwal
Call quality is not great.
Operator
Yes. Please go ahead.
Prakash Agarwal
Yes. So pardon if I’m asking this again, but 2 questions. One is, how should we think about the base business performance given there is some competition in your key products? Would it be largely flattish or it would have come down? And secondly, on the volume restricted launch that you have done, most or all of it is already booked for the…
Operator
I’m sorry, your voice is breaking again.
Prakash Agarwal
I’ll repeat my question.
Erez Israeli
Yes. Parag, I think you have heard the question.
Prakash Agarwal
Okay. So what is the performance on the base business in the U.S. side, how it would have been done? Is it flattish or it would have declined? And second is on the volume restricted launch that you have done for generic Revlimid, most of it is booked or there is more to be booked in the financial year ’23?
Erez Israeli
So on the second one, we are going to book sales for this product in Q2 and Q4 and in the years to come. And so we — so it’s not that it’s a onetime. We are planning to continue to sell this product in a meaningful manner also in the next coming quarters. As for the first question, I would — the best way to discuss it is we are very consistent, meaning that even if you — on the long-term basis, and that’s something we are very trying to be very considerate our communication, our U.S. market, our U.S. activities will grow is growing in the single digits on a month year basis while from time to time, we have mix ups and leaks down in accordance to the competition. This quarter, indeed, we had competitions for some key products like Cosentyx, Bbox. And against that, we launched product and we’re going to launch 25 products. Overall, our U.S. market will continue to grow in the same manner that we discussed in the past. And we will have from time to time products that will contribute more meaningfully for a certain period of time. So the answer for that is we are consistently what we discussed in the previous meeting as well.
Prakash Agarwal
Okay. And just to think that I understood the second part of the question correctly, you said there is more to come in Q3 and Q4 with respect to Revlimid.
Operator
We have a next question from the line of Kunal Dhamesha from Macquarie Capital.
Kunal Dhamesha
First one on the gross margin. So we have kind of improved gross margin by 550 bps. Can you just quantify various moving pieces here? I think we have product mix, PLI approval, FX impact and then offsetting is the total product provision and the price erosion.
Parag Agarwal
Yes, Kunal. So our gross margin for the quarter, we have reported at 59%, and it has — as I stated, it is strong because of favorable product mix. including the impact of new product launches. So that’s clearly something that’s pushing it upward. We have also recognized the benefit of PLI and a few other normal export incentives like DVD, etcetera, during the quarter. We have also taken a provision of around INR100 crores for covet product inventory as the sales have come down quite a bit, as you would know. So overall — and there is, of course, a little bit of cost inflation that sitting in these numbers. There is some softening we are seeing in installments, which could have some favorable impact in the second half, but cost still remain at an animated level. So overall, I would say that, yes, this is what the gross margin is there about. I would just point out that we you need to take out the impact of new product launches during the quarter. our gross margin is within the normal range that we have been consistently talking about, which is somewhere between 5% to 54%.
Kunal Dhamesha
And would you be able to share some insight in terms of why our ANDA filing run rate remains low. I think in FY ’20, we filed around 8 NDS FY ’21 was slightly better at ’20 and then FY ’22. If I look at this year’s run rate first half is around 4 NDS filing while our R&D continues to remain at hates. So any insight into why our E&D run rate filing is low?
Erez Israeli
Yes, it’s more of a timing within the year of the submission. Normally, most of the submissions are done in the second half of the year. So you are going to pick up of those numbers. As for the overall numbers, we are focusing our R&D as much as Patagonia for that on the biosimilars on products that we have bigger potential. So it’s — so we are trying to target not 40 products per year, but rather maybe lower number of the debt around the 2025 products per year, but those products with the potential to be first to market, meaningful growth, etcetera. So what you see here is also a combination of timing as well as focus on the R&D across markets, not just for the U.S. market. The products that we have developed in the U.S. market, we are also launching in other markets, especially in ingestables. So they like — actually the value that can derive from the R&D should be higher in the future while those relevant products will be launched in the near future, being global, more complex, more injectable non-biologics [ph].
Operator
We have our next question from the line of Damayanti Kerai from HSBC.
Damayanti Kerai
My question is on India fees. So even after adjusting for COVID base and sale of some noncore brands for the quarter, sequential growth rate is around mid-single digits, which is lower than market growth of double digit. So how should we see growth moving ahead? And what will be the key drivers? So a few years back, you mentioned about growing your India sales by almost 50% on the base existing at that time. So are you broadly on track to achieve that?
Erez Israeli
Yes, we are on-track. We are very confident that we are on track. What we see now is a combination. First, we are long focus. So as part of our strategy and as discussed in previous meetings, we identified certain segments that we want to focus on. And for those focus to put our resources behind meaningful brands that can grow and sustain for many years as well as investing in what we call Horizon 2, which India is going to be a big outlet for that. As part of this, we are divesting brands as well as focusing on brains. For example, the brand that we acquired recently as well as [indiscernible] which is an area of lytics [ph], the vascular and more chronic in nature. We do have some brands that if not do well, and we are fixing those. And I’m very confident that this will happen as well. So bottom line, I’m very confident that we are going to see it very solid and we are reiterating that are going to be a profile in India, and we are planning to achieve that.
Damayanti Kerai
Sure. My second question is on injectables. So this has been one of your focus segment. So can you talk a bit about the competition outlook for this segment, given we have seen like competition rising in this segment. So how do you see competition scenario building up in injectables over the next few years?
Erez Israeli
As the patent please, we invite people to invest behind products that we have patent exploration in this time. And naturally, as part of the way portfolio was built by the nares, there are more and more investable that will be coming this patencies; many actually — many companies have injectable pipeline and exactly to increase in the future. So we do see the injectable business is very competitive. We see two advantages and differences in the injectable business that are different, maybe those that used to be in over-alert channel is different. It’s selling to hospital. It’s selling globally. We can use one and around the world, and we’re going need to do a bio study continent. So the gross margins are higher and some of these products, the technological bar is also higher. So given all of this, we believe that we will see more growth to achieve better margins on a global scheme. At the same time, every product will face competition and where competition will come, it will be us first, I say, any other segments or generic segments, this is likely to be also for index.
Damayanti Kerai
Sure. And my last question is a clarification on PLI scheme benefit. Is it one-off you are likely to book it every year or like in next quarters also?
Parag Agarwal
This is clearly not a one-off. This is seen that, as you know, it’s a multiyear scheme. And even within this year, it is not a one-off. Of course, the quantum fluctuate from one quarter to another, depending on the sales of the products that qualify for the rise.
Operator
We have a next question from the line of Surya Patra from Philip Capital.
Surya Patra
Yes. My first question is on the cash flow that we are likely to be generating from Red Limit. So in fact, Dr. D has been a kind of a consistent generator of free cash flow, over INR1,000 crores kind of annually. And this evolute way that contribution that we are witnessing it is obviously over INR1,000 crore kind of a per annum contribution that we are definitely likely to see — so given that your qualitative growth outlook, if you can give some utilizing this cash flow situation. So obviously, your growth can be qualitative and consistent over next few years. So can you give some clarity about what would be your key priorities here going ahead, looking at the kind of strong cash flow generation situation?
Erez Israeli
Yes, thank you. Indeed, I agree with you, we are building a very healthy cash flow position and which exactly to get to over the — so the cat naturally post the basic to use it for CapEx to use it for buying and building the future of technologies and to use it for our working capital. We will naturally have excess of that. The second is to build development. We are actively looking for deals across all of the geographies that twist our strategy, both on Horizon 1 as well as Horizon Go. We feel also that the geopolitical situation as well as the economy situation creates an opportunity for us. In that place, we do see opportunities that maybe in the past were in higher valuations. And so, likely that we are going to be very busy with this development in the next coming quarters. And if since we left, we will consider, of course, out of this is maybe for the shareholders. We do not — we did not take a decision about this kind of stuff, like buyback or dividends. But what we can assure that we will have a use for the money, the money will be used in that order of priorities.
Surya Patra
Sure. So in fact, whether it’s like even the R&D, although there is a kind of significant growth that we are witnessing from Revlimid. But accordingly, the R&D spend has also gone up. That was earlier indicated that way. So you think with the kind of a ramp-up in the business, the R&D spend and the investment on the specialty project, all that is likely to go up quite meaningfully.
Erez Israeli
That’s why if you recall in the past, we guided that we are comfortable with 25% EBITDA, which in one — in some quarters, we’ll do more, some quarters will do less this quarter. And maybe also in other quarters, we’ll do more. So absolutely, this is the idea that this will help us to pay for the R&D for the Origin OpEx activities, knowing our pipelines and knowing the cash position, that’s why we felt very comfortable to commit in June that we can finance Horizon 2, while including the R&D associated with the including the R&D associated with the resin one, while speaking the overall guidance of EBITDA of 25% on a multi basis. And yes, we believe that we are in a very comfortable position to do both organic and inorganic, not just because of this product also from loans of other products and other activities that we will do in the next coming years.
Surya Patra
Sure, sir. My second question is on the preclaim for the biosimilar. How should we see this as an opportunity for us because our partner fashions Kai has already got the USFDA approval for that. So how influenced or this product opportunity would be for us. My only key query here is that what is the kind of association that we are having here because it has been filed in the name of net. The manufacturing base is also used from freshers base only. So then what is the kind of relation that we are having for this opportunity?
Erez Israeli
Yes. This is a residual agreement that we had in the past, activities with milk, the German nurse that was acquired by Fresenius. And so the product was developed by us initially and a second before. And so we are entitled to royalties, meaningful royalties start of the launch. Like you said, rightly so, we are not participating in the actual production, but we will share the success once we sell the product.
Surya Patra
Okay, sure. Sir, just one clarification. You mentioned about the INR100 crore provision. Is it relating to the PSI and this INR193 crores of government grant that is what is the PLI amount, these 2 clarifications.
Parag Agarwal
Yes. So the amount of government grants includes PLI and the other export incentives that we received. So it’s a total amount. Sorry, what was your first question?
Surya Patra
On INR100 crores provision, is it relating to the PSI?
Parag Agarwal
Yes, it is across all businesses. It is for India as well as CSI and also in emerging markets. So it’s an aggregate provision across all geographies.
Surya Patra
But is it possible to share for PSA?
Parag Agarwal
We don’t share business specific numbers.
Surya Patra
Because this is a quarter-specific one.
Erez Israeli
Let’s say that without the cover the gross margin of the API will absolutely grow…
Parag Agarwal
High single digits. I would put it as high single digits yes. So without adjusted for profit provision, the gross margin for PSAI would have been high single digit.
Operator
On behalf of Dr. Reddy’s Laboratories Limited, that concludes this conference. Thank you for joining us, and you may now disconnect your lines.
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