Very well compiled Sandeep.
On the risks side, the key risk to be watched out here is acquisitions. Two large acquisitions in the past that have not gone well for Dr Reddy’s:-
2006 : Dr Reddy’s acquired Betapharm group for c. $570m in all cash deal, which was the 4th largest generics company in Germany at that time. The intent was to expand presence in global generic markets and diversify away from US markets. The deal was funded through mix of accruals and debt (including recourse debt to Dr Reddy’s India and non-recourse debt at German co.).
Almost a year after the acquisition, German government undertook healthcare sector reforms turning an attractive branded generics market in Germany to a predominantly commoditized tender driven business, significantly reducing the drug prices and margins. As a result, by 2010, Dr Reddy’s had written off more than 80% of the acquisition cost. They paid off all the debt (including non-recourse debt raised in Germany) from Dr Reddy’s other cash flows (which speaks about their management integrity!).
Clearly this went wrong but for no fault of theirs and was just bad luck in terms of timing.
2016 : Dr Reddy’s acquired a portfolio of eight Abbreviated New Drug Applications (ANDAs) in the US for $350 million (c. Rs 2300 crs) in cash from Teva. The combined sales of the branded versions of the 8 products in the U.S. was approximately $3.5 billion MAT for the most recent 12 months ending in June 2016 according to IMS Health. These molecules were expected to drive growth in the medium term.
Of this, c. Rs 1340 crs (c.58%) was impaired in FY 20 due to launch of gNuvaring by competition leading to loss of potential cash flows for Dr. Reddy’s.
Acquisition strategy remains a risk for any pharma company and needs to be watched out for (especially if it is a large one). Acquisitions haven’t played well for many other pharma companies as well like Lupin -Gavis, Sun Pharma – Ranbaxy etc.
For Dr Reddy’s with annual cash flow generation of c. Rs 2,000-3,000 crs, this risk again becomes center-stage. Though the new Executive Management can be expected to certainly be more cautious and twice shy (also evident in their stated strategy of – “creating more opportunities with less risk”).
On the other side, clearly the new CEO clearly has brought transformational changes here evident in increase in EBITDA margins from 17% in FY 18 to 27% in FY 20 (excl impairments). Even US FDA issues which were pending for 5+ years were finally sorted.
Looking forward from here, appended below are snippets from last few call transcripts which highlight the possible upsides to their business:
1. API Space (Q4 FY 20 Transcript) -
There are certain structural tailwinds also for us, such as opportunities for improving our market share across multiple markets and ramping up relevance in our global API business. Overall, we remain hopeful to continue to grow and emerge as a much stronger company, meeting the expectations of all of our stakeholders.
2. Productivity/Increase in EBITDA margin (Q3 FY 20 transcript):
Question: So firstly, on the cost management. How close are we to sort of achieving the optimal cost structure that you would have desired?
Answer: I cannot quantify these numbers, but there is still a lot of room to be better. The goal is to be the most efficient company on earth in our space, and we are very far from there. So, we will continue to see these efforts also going forward.
Question: Okay. And just in terms of your commentary in some of your calls where you said that the ideal metrics that you want to target is a 25% EBITDA with a 25% ROCE. Do you think that’s something which is achievable over the next 2, 3 years? Or you would target that for the next year itself? How would you think about that goal?
Answer: We achieved already for this quarter, 24.5% on the EBITDA overall. So we are very close and I believe that it’s achievable. And I believe that it’s achievable basically not just as overall, but it’s relevant actually for every activity that we want to do which means that the average can be even higher in the future.
Question: You expect this EBITDA margin to expand substantially over next 2-year period?
Answer : I believe that we can do much better on the EBITDA. Yes, absolutely.
3. Capacity utilisation (Q3 FY 20 transcript)
Today, as we told that there are some assets in our networks, which is quite underutilized. But overall, utilization level is also something when we can do much more with the current level of investment or our network that we have created.
…
If they deliver on the above lines, this could give further impetus to the projections given above (through increase in margins).