DSIJ Mindshare

Rx: Ranbaxy or Dr. Reddy's?

The patent expiry on blockbuster innovator drugs in the US has come as a huge opportunity for the Indian Pharma sector, giving a global identity to many Indian companies. Two companies which have been major gainers of the patent expiry game are Ranbaxy and Dr Reddy’s Laboratories (DRL). Touted as highly competitive international generics players, we believe that both companies are strong pillars of the Indian Pharma sector. Ranbaxy has crossed the Rs 10000 crore revenue mark in CY2011 and DRL is expected to cross this mark soon (9M FY12 revenues of Rs 7015 crore).

At a time when both the companies have launched blockbuster drugs in the USA and have shown a fiery topline growth, investors would be looking forward to good results ahead. Here is a comparative analysis of both the companies, which will provide an insight about their future prospects.

Ranbaxy’s landmark achievement of crossing Rs 10000 crore in revenues has come after over 50 years of operations. DRL, on the other hand, is a comparatively younger company than Ranbaxy (by 27 years), and hence crossing Rs 10000 crore in revenues will surely be a very significant achievement for the company.

Ranbaxy derives 80 per cent of its revenues from exports and the remaining 20 per cent from its domestic business. DRL is also on the same trajectory, with about 18 per cent of its revenues coming from the domestic market and 82 per cent from exports. The domestic market conditions remain very competitive, with high pricing pressure as well as the crowding of manufacturers.

On the back of their moderated growth on the domestic front, we believe that the international market will decide the growth of both of these companies in the future. The market for off-patent drugs is expected to be well over USD 70 billion by 2012, which is why the generics market is witnessing a rapid growth internationally. Besides, the governments in regulated markets are favouring the use of generics in a bid to cut healthcare costs, which is another factor that will bring in growth for companies operating on the global level.

However, we expect a slower growth in the European markets, as government spending in those countries is expected to be slower due to the ongoing debt crisis. We believe that this may result in aggressive bidding by local governments to control expenses, which will in turn result in low priced tenders. The North American market (prominently USA) remains a key growth market due to the patent expiry regime as well as the increased use of generics. Among other markets, Africa and Brazil will continue growing in double digits going ahead.

In this background, it is interesting to note that both these companies have operations in the regulated markets (US, Europe, Japan) as well as in emerging markets (the Asia Pacific region, Brazil, Russia, African countries, etc.). Ranbaxy’s revenues in exports have gone up at CAGR of 11 per cent (by December 2011) in the past four years, as compared to the 15 per cent CAGR reported by DRL by FY11. The growth rate of DRL in the North American market including USA (26 per cent) looks even better when compared to that of Ranbaxy (20 per cent). USA is the most important market for both the companies, as they earn one-third of their revenues from this market, and this has been increasing over the years.[PAGE BREAK]

However, there are more troubles for Ranbaxy in the US than for DRL. In 2008, the US Food and Drug Administration (USFDA) issued warning letters and put an import alert on its Paonta Sahib and Dewas capacities. This resulted in an import ban on 30 products being exported by Ranbaxy to USA. Both these plants have not been cleared by the USFDA till date. In fact, Ranbaxy took nearly four years to take positive action against this ban.

The ban resulted in a revenue loss for Ranbaxy in 2009, in which its total revenues remained almost flat. This also impacted its Abbreviated New Drug Applications (ANDA) filings as well as its First to File (FTF) portfolio. As per a recent conference call, the company is letting go of three FTFs from its portfolio. The management has not indicated which FTFs will be wiped out, but it expects that the revenue loss will be minimal. FTFs are key for the US market – an FTF holder company gets 180-day exclusivity in which it can sell the generic versions of innovator drugs. Companies have earned bolstering revenues from this, and Ranbaxy letting go of three FTFs will be seen negatively by the markets. We believe that an import alert as well as the foregone benefit of the FTFs is weighing heavily on the stock.

Ranbaxy recently launched a generic of the blockbuster Atorvastatin (brand Lipitor, held by Pfizer, annual sales of over USD 10 billion as per IMS data). It is currently holding the highest market share, and earned around Rs 1200 crore in revenues from this drug during the December 2011 quarter. However, this is not seen as satisfactory due to the revenue share agreement with USA-based Teva Pharma. Even though the quantum of the revenue share has not been disclosed by the company, we believe that it is to the tune of 50 per cent of Lipitor revenues, which is quite heavy and will eat away all the premium of earning FTF status on this block buster drug.

That apart, it also has entered into a consent decree with the USFDA and has made a provision of USD 500 million (Rs 2648 crore) as settlement fee, which, we are afraid, is way too high than that seen in earlier cases. Previously, the resolution of such an issue took about two-three years on the lower side and over five years in some cases. Some consent decrees signed are still pending with the USFDA. Ranbaxy has hired experts in this matter, but the resolution may take more than a year and a half. With high competition in the generics space, the USFDA is also seen becoming aggressive on approvals, and hence, Ranbaxy may see a further regulatory pressure. Assuming that the matter gets resolved soon, it will face very high competition in those 30 products, due to which the impact may not be very high. Besides, if the USFDA finds non-compliance, then some of its other USFDA-approved facilities may also come under the scanner. This could worsen the matter and attract a financial penalty as well.

Understanding The Consent Decree

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DRL, on the other hand, seems very certain about launching its ANDAs and FTFs. The recent launch of the generics of Zyprexa and Caduet on its own was highly profitable to the company. It earned about USD 99 million in revenues in the December 2011 quarter alone. This year, DRL is expected to launch the generic versions of Avandia (sales of over USD 1.1 billion), Clarinex (sales of about USD 300 million) Seroquel (sales of over USD 2.9 billion), Lipitor (sales of over USD 10 billion), and hence, one can expect a further rise in its revenues.

On the regulatory filings front, DRL looks like an attractive bet as compared to Ranbaxy. We understand that Ranbaxy had an FTF status on seven drugs by 2010. With Lipitor already launched and the company letting go of three FTFs, Ranbaxy’s FTF portfolio doesn’t look very promising. Two blockbuster drugs on which Ranbaxy has an FTF status are going off patent this year – Diovan in March 2012 and Actos in August 2012 – and we remain skeptical about them. On the other hand, DRL has launched several products this year, with the latest launch of Geodon slated in March 2012. The company also expects to launch Lipitor in May 2012. DRL has possible exclusivity on 38 products, with 10 confirmed FTFs. Ranbaxy’s regulatory filings have declined, and those of DRL currently stand higher. Regulatory filings are the future opportunity in the global markets and they indicate that earnings will be higher in the future.

 Drug Master Files
(DMFs)
Regulatory Filings
Year Ranbaxy DRL Ranbaxy DRL
2008/FY09 271 351 278 159
2009/FY10 170 378 245 179
2010/FY11 167 486 161 179

Coming to other markets, DRL has grown at a CAGR of 25 per cent in Russia, where Ranbaxy has taken a back seat. Though Ranbaxy remains strong in the European markets, we believe that its future earnings may not be very strong, as the pricing pressure will remain dominant. Brazil, where many Indian companies are seen focussing, will give equal opportunities to both the companies. Ranbaxy’s installed capacities of tablets, capsules, ampoules, vials and APIs have remained almost flat over the last three years (the company’s 2011 Annual Report is yet to be published). DRL, however, has seen an increase in its generics and formulations capacities. The growing production numbers of DRL also hint towards future profitability, and we remain positive on the same.

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Valuations And Financial Performance

Ranbaxy’s performance for CY2011 has been far from satisfactory. The company reported a 16 per cent growth in its sales to Rs 9976 crore, thanks to the launch of Lipitor. Its overall topline was up 13 per cent to Rs 10161 crore. On the bottomline, however, the company reported a loss of Rs 2899 crore (after minority interest).

DRL, in its nine monthly results for this fiscal, has reported a 29 per cent jump in its topline to Rs 7015 crore. Its net profit increased sharply by 44 per cent to Rs 1107 crore. It has shown a growth in all the geographical segments. The company is expected to commission its manufacturing facility in Mexico this year.

As of December 2011, Ranbaxy has Rs 4490 crore in debt, while DRL has Rs 3850 crore on its books. Besides, Ranbaxy’s debt-to-equity ratio of over 1x looks high as compared to that of DRL at 0.42x.

On the valuations front, at an EV/ EBITDA of 11.8x, Ranbaxy looks cheaper as compared to DRL’s EV/EBITDA of 12.6x. However, we believe that DRL is commanding this premium over the certainty in its earnings as well as a decent pipeline of regulatory approvals. We recommend DRL over Ranbaxy to investors.

Financial Information (Rs/Cr)
ParticularsRanbaxy
CY2011
DRL
9MFY12
Total Income 10161.41 7015.29
Total Expenditure 8936.48 5607.19
Operating Profit 1224.93 1408.1
Interest Expense (Gain) 434.01 -7.77
Tax 196.93 336.65
Net Profit (Loss) -2899.73 1083.5
Equity Capital 211 84.76
EV/EBITDA                                            11.8x                                            12.6x

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