V. Prasad, the Co-chairman and CEO of Dr. Reddy's, is more comfortable discussing weather and climate change than the heat his company is facing from the US drug regulator. To a small group of journalists who were a bit early for the 2016/17 results press conference, Prasad, an avid photographer, instead of discussing the ongoing inspections of plants by the US Food and Drug Administration (USFDA), chose to show the pictures he had shot of the aftermath of the intense hailstorm that had hit Hyderabad a week ago. The pain of seeing a dead bird seemed easier to handle than discussing where the USFDA inspections were headed. Those who know Prasad say he has been personally disheartened by the reversals the plants have faced following re-inspections by the USFDA. These include the three plants on which the USFDA had issued a warning in November 2015.
While the run-in with the USFDA is top priority, it is not the company's only headache at the moment. Among other things, it is staring at a margin hit due to price caps and mandatory generic prescriptions in India. Two, it is struggling with lack of sufficient new product approvals in the US, from where it gets half its sales, and increasing competition there. And then there is the below-par performance of two businesses - proprietary and biosimilar - from where it has great hopes.
The stress is showing. In 2016/17, revenues shrunk 9 per cent, after rising 4 per cent in 2015/16. In the US, the fall was 16 per cent, as the company did not have "any significant product launch" during the year. It also took a hit from competition in the US for key products such as Valganciclovir, Decitabine and Azacitidine. Revenues from Valganciclovir, a popular anti-viral pill, for instance, fell to half. In emerging markets, revenues dipped 11 per cent, largely on account of "constrained operations in Venezuela".
The company says it is working to fix these problems, and more, to become future-ready. The question is, can it pull it off?
Investors so far do not seem convinced. Dr. Reddy's shares have lagged the pharmaceutical index as well as the BSE Sensex by a fair margin over the past two years.
The company is facing what is probably its worst-ever regulatory hit from the USFDA inspections. This despite giving the matter top priority and engaging the best, and some say the most expensive, US-based consultants. However, going by the outcomes of the re-inspections, it seems the worst is not over yet. The USFDA team is visiting India more regularly than before.
Out of the three facilities against which the USFDA has issued warnings and undertaken re-inspection, analysts, after going through the contents of the letters with their consultants, say that the observations for two API facilities - Srikakulam and Miryalguda - are not so critical. Only in case of Duvvada, the injectable formulations unit in Vizag, are the comments critical and could take three-four quarters to get resolved. "Dr. Reddy's faces a number of challenges?not only has the near-term outlook turned negative owing to recent developments, the long-term outlook, too, remains uncertain," analysts at Edelweiss said in a report in April.
Saumen Chakraborty, President, CFO, and Global Head of IT and BPE, says among the top priorities, the number one is "resolving and addressing the USFDA observations from the recently-concluded plant audits."
Beyond Regulatory Issues
The company is also facing the brunt of a lot of structural changes in the US. These include trade channel consolidation and resulting pricing pressures. For instance, the US today has only four large wholesalers and chains that source generic drugs compared with around a dozen three years ago. This means additional bargaining power and pricing pressure. Plus, there is increased competition for a number of products, including from other Indian companies. For instance, in case of Valganciclovir, its $100 million molecule, the number of players has more than doubled. Two of them, Aurobindo Pharma and Hetero Drugs, are from India. Also, the race to launch products going off patent in the US is becoming more competitive than ever.
Dr. Reddy's, to tackle these issues, can look beyond generics at biosimilar and proprietary products (where the focus is innovation on existing generic drugs to come out with niche therapies, such as in dermatology and neurology). But while it has been investing in these areas and has apparently "gained expertise in how novel products can be built and marketed," as Prasad puts it, these investments are yet to start giving returns. The company has launched two proprietary products so far. It has a pipeline of products in this space and expects to see these contributing significantly to the top line by 2022/23.
In biosimilars, Dr. Reddy's was one of the earliest movers, in 2007. While analysts agree that biosimilars have a long gestation period, they also refer to how Biocon, with Mylan as partner, has been taking this space by storm. In November last year, it announced USFDA submission for a biosimilar, Trastuzumab. Analysts question Dr. Reddy's developed market strategy for biosimilars, where it operated with a partner for developing the portfolio. It originally had a partnership with Merck KGaA, which sold its biosimilar business to Fresenius Kabi in April 2017. Dr. Reddy's will now have to work with Fresenius in biosimilars.
The other option for Dr. Reddy's is to build the biosimilar business in emerging markets, where it is on its own. Here, it is now focusing on rolling out its top-selling biosimilar, Reditux, in various emerging markets. But where does all this leave the company?
The Promise Pipeline
In the all-important generics space, during 2018 and 2019, a lot of products are in the pipeline. While the company does not share details on this, it is estimated that nearly 50 per cent (if not more) will be filed through the partner site, which means another company could be a collaborator in product development/manufacturing. This strategy is adopted by companies as a de-risking tool given the increased regulatory scrutiny. It reduces dependence on own plants and diversifies production locations, even if it adds to costs.
How this translates into growth depends on the number of approvals it gets. Chakraborty says these drugs have a huge revenue-earning potential. Analysts agree that over the next three-four years, if all the products in the pipeline are launched, the current US business could move from around $950 million today to over $1 billion, may be even close to $1.6 billion. One important growth driver is expected to be the eight Abbreviated New Drug Application (ANDA) portfolio from Teva that the company acquired in June last year for $350 million. It is a mix of filed ANDAs pending approval and an approved ANDA and comprises complex generic products. Prasad was then quoted as saying that the deal with Teva "will add strength to our product portfolio, help us become more relevant in the US market and create new opportunities for growth." There is expectation that most of these products will be contract-manufactured by a company.
New Markets, Different Products
Prasad has often maintained that the US is, and will remain, the largest market for the company. Nevertheless, he says, "we are on the path of global expansion in terms of newer geographies. We have expanded our presence in China through a 'rep office' apart from building presence in emerging markets."
The company has expanded its foothold in Colombia and Brazil and plans to do so in Chile and North Africa, led by Algeria. In Europe, it is moving beyond Germany and the UK into France, Italy and Spain. The focus is building the institutional business, led by oncology products. Another growth driver, in spite of the challenges, can be the biosimilar business, says the company. But the key market for biosimilars is the developed world where, analysts say, the company has been late. One option it is banking on is building the biosimilar business in emerging markets and India, where the company can go on its own. The company expects to see this business increase from $40 million today to between $150 million and $200 million in the next three to four years. If that happens, and other plans fall into place, Prasad may need the microphone more than the camera. ~