Dr. Reddy’s Laboratories Equity Research

Date of Research – 14 January 2016

Price – Rs. 2,913.10

About the Company

Dr. Reddy’s Laboratories Limited (“Dr. Reddy’s” or the “Company”) is a pharmaceutical major with its presence in over 25 countries. The Company operates through its three businesses – Pharmaceutical Services and Active Ingredients, Global Generics and Proprietary Products.

STRENGTH

[1] Large emerging-market presence Dr. Reddy has a strong brand presence in many emerging markets particularly Russia and India where rising disposable incomes and fragmented customer base offer attractive growth opportunities.

[2] Market share gains in the U.S. markets In the U.S., Dr. Reddy has grown quickly in over-the-counter generics, which is an attractive segment of the market with high barriers to entry. The company is also able to launch difficult-to-manufacture drugs with limited competition, such as Arixtra and Allegra.

CHALLENGES  

[1] Intense Competition Competes with various pharmaceutical companies that have similar products in the same market but manufactured at facilities which have been approved by the highest regulatory authorities in the United States and Europe.

[2] Regulatory Environment Risk due to adverse developments in regulatory environment and statutory provisions. National Pharmaceutical Pricing Authority (NPPA) controls and regulates the prices of pharmaceutical drugs in India. Price controls imposed by the authority are unpredictable and have a negative impact on company’s profitability margins.

[3] Not Considering Inorganic Growth The company has increased its reach into Europe through acquisition of Betapharm, a German generic manufacturer, for $570 million. Betapharm’s performance was not as expected and its losses have forced Dr. Reddy to take significant write-offs on its assets. The company is not considering any future potential international acquisitions.

Key Financial Figures

Standalone(Rs. Cr)
ParticularsFY 2013FY 2014FY 2015FY 2016FY 2017
Total Income from Operations8,434.019,728.0510,010.9410,207.709,719.80
Expenses6,448.346,966.317,619.947,803.707,974.20
Earnings Before Other Income, Interest, Tax and Depreciation (Operating Profit)1,985.672,761.742,391.002,404.001,745.60
Depreciation312.85380.50490.23649.10735.10
Finance Costs61.4078.3163.8063.8057.20
Other income141.71151.46222.85244.80591.20
Exceptional items355.90
PBT1,753.132,454.392,059.821,580.001,544.50
Tax487.66521.55380.47225.50160.40
PAT (before Minority Interest and share of Associates)1,265.471,932.841,679.351,354.501,384.10

Profitability Analysis

Standalone(%)
ParticularsFY 2013FY 2014FY 2015FY 2016FY 2017
Operating Profit Margin Ratio23.5428.3923.8823.5517.96
Net Profit Margin Ratio15.0019.8716.7813.2714.24

Operating profit margin is a measurement of the proportion of a company’s revenue that is left over after paying for production costs such as raw materials, salaries and administrative costs. Net profit margin is arrived at by deducting non operating expenses such as depreciation, finance costs and taxes out of operating profit and shows what is left for the shareholders as a percentage of net sales. Together these ratios help in understanding the cost and profit structure of the firm and analysing business inefficiencies.

Key Balance Sheet Figures

Sources of Funds / Liabilities(Rs. Cr)
ParticularsFY 2012FY 2013FY 2014FY 2015FY 2016
Share Capital84.8084.9085.1085.2085.30
Reserves & Surplus4,904.206,284.207,780.109,767.9011,615.60
Net worth (shareholders funds)4,989.006,369.107,865.209,853.1011,700.90
Long term borrowings1,641.901,265.902,075.501,431.501,069.00
Current liabilities4,591.405,658.805,790.406,821.306,836.80
Other long term liabilities and provisions101.9086.40174.40351.20344.50
Deferred Tax Liabilities107.00124.10140.7059.20
Total Liabilities11,324.213,487.2016,029.6018,597.8020,010.40
 
Application of Funds / Assets(Rs. Cr)
ParticularsFY 2012FY 2013FY 2014FY 2015FY 2016
Fixed Assets4,120.204,615.905,279.605,906.007,226.50
Noncurrent Investments0.900.400.40145.60145.60
Current assets6,999.008,591.0010,325.7011,876.7011,820.10
Long term advances and other noncurrent assets204.10105.70232.20424.50532.90
Deferred Tax Assets174.20191.70245.00285.30
Total assets11,324.213,487.2016,029.6018,597.8020,010.40

Efficiency Analysis

 (%)
ParticularsFY 2012FY 2013FY 2014FY 2015FY 2016
ROCE36.6026.0127.7821.1918.83
ROE / RONW26.1019.8724.5717.0411.58
Return on Capital Employed (ROCE) measures a company’s profitability from its overall operations by calculating the return generated on the total capital invested in the business (i.e. equity + debt). Return on Equity (ROE) or Return on Net Worth (RONW) measures the amount of profit which the company generates on money invested by the equity shareholders. In short, ROE draws attention to the return generated by the shareholders on their investment in the business. Together these ratios can be used in comparing the profitability of the company with other companies in the same industry.

Valuation Analysis

Standalone 
ParticularsFY 2013FY 2014FY 2015FY 2016FY 2017
Total Income from Operations (Rs. Cr.)8,434.019,728.0510,010.9410,207.709,719.80
Growth (%)(14.07 %)15.34 %2.91 %1.97 %(4.78 %)
PAT (Rs. Cr.)1,265.471,932.841,679.351,354.501,384.10
Growth (%)(2.72 %)52.74 %(13.11 %)(19.34 %)2.19 %
Earnings Per Share – Basic (Rs. )74.54113.6798.6079.4283.05
Earning Per Share – Diluted (Rs. )74.17113.1398.1879.4282.88
Price to Earnings23.8120.5636.5338.2130.47

Dividend History

The Company has maintained an average dividend yield of 0.68 % over the last 5 financial years.

Liquidity and Credit Analysis

Current Ratio

Higher current ratio implies healthier short term liquidity comfort level. A current ratio below 1 indicates that the company may not be able to meet its obligations in the short run. However, it is not always a matter of worry if this ratio temporarily falls below 1 as many times companies squeeze out short term cash sources to achieve a capital intensive plan with a longer term outlook. Dr. Reddy’s average current ratio over the last 5 financial years has been 1.54 times which indicates that the Company is comfortably placed to pay for its short term obligations.
 
Long Term Debt to Equity Ratio
 
Companies operating with high long term debt to equity on their balance sheets are vulnerable to economic cycles. In times of slowdown in economy, companies with high levels of debt find it increasingly difficult to service the interest on their borrowings as profit margins decline. We believe that long term debt to equity ratio higher than 0.6 – 0.8 could affect the business of a company and its results of operations. Dr. Reddy’s average long term debt to equity ratio over the last 5 financial years has been 0.21 times which indicates that the Company operates with low level of debt and is placed well to withstand economic slowdowns.
 
Interest Coverage ratio
 
Interest coverage ratio indicates the comfort with which the company may be able to service the interest expense (i.e. finance charges) on its outstanding debt. Higher interest coverage ratio indicates that the company can easily meet the interest expense pertaining to its debt obligations. In our view, interest coverage ratio of below 1.5 should raise doubts about the company’s ability to meet the expenses on its borrowings. Interest coverage ratio below 1 indicates that the company is just not generating enough to service its debt obligations. Since Dr. Reddy’s operates with very low levels of debt, its average interest coverage ratio over the last 5 financial years has been 38.25 times which indicates that the Company can meet its debt obligations without any difficulty.

Ownership pattern

In its latest stock exchange filing dated 31 March 2017, Dr. Reddy’s reported a promoter holding of 26.79%. We believe that a greater than 35 % promoter holding offers safety to the retail investors. However, given the size and management structure of DRL we do not doubt the conviction and sincerity of the promoters.
 
At the same time, institutional holding in the Company stood at 41.91 % (FII+DII). Large institutional holding indicates the confidence of seasoned investors. At the same time, it can also lead to high volatility in the stock price as institutions buy and sell larger stakes than retail participants.

About the Author

Rajat Sharma pictureRajat Sharma is a well known stock market analyst and commentator. He has covered Indian markets for over a decade and is regarded for consistently identifying early stage investment opportunities. Attorney by qualification, Rajat has done extensive work for improving corporate governance and disclosure standards.