The first quarter of FY11 for Dr Reddy’s Labs has proved to be mixed bag. While the prospects for its business in US contributing 30% to revenues appear strong, it also got some setback with Allegra D24.

DRL's existing product pipeline got strengthened during April – June 2010 quarter with addition of three more opportunities in ParaIV/low competition products. The total number of ParaIV/low competition products has now increased to five – namely Arixtra, Prilosec OTC, Prograf, Lotrel and Clarinex. These products have potential to drive PAT up by Rs 270 crore in FY11 and Rs 220 crore in FY12E as per analyst estimates. On the other hand, the company saw one Para IV product launch being delayed in the recently concluded quarter due to an adverse court order. Thus generics of Allegra D24, Sanofi’s $180 million anti-allergic drug cannot be launched by DRL till it wins the appeal.

On the revenues front, despite a 36% growth in Russia & CIS countries (Rs 260 crore) and 16% growth in Indian markets (Rs 280 crore), DRL felt the heat in US and European sales in Q1FY11. US revenues growth was muted as sales declined 1% compared to last year, excluding Imitrex. Another 6% reduction in Betapharma sales pushed European revenues down by 8% to around Rs 182 crore.

The robust growth in CIS was in the back of re-stocking and volume expansions. In the domestic market, the prescription sales growth of 22% and outperformed the industry prescription sales growth of 20%. Another 11 new product launches in the domestic market were seen during the quarter.

Pharmaceutical services and active ingredient (PSAI) segment sales at Rs 487 crore declined 7.6% with 15% dent in North American sales. Thus consolidated sales for DRL at Rs 1,618.13 crore in the Q1 FY11 quarter declined 7.5% compared to the previous corresponding quarter.

Higher fixed overheads in PSAI segment caused gross margins in the segment to decline from 31% last year to 19% now.  Another 170 basis point increase in raw material costs caused 210 bps declines in OPM of recurring business excluding Imitrax. Going forward, the margins are likely to improve with SGA costs in Beta pharma coming down from 4-5 million Euro/month earlier to 1.5 million Euro/month now. This coupled with increasing contributions by higher margin Omeprazole OTC and generic Prograf as well as strong momentum in domestic market will accrue well to margin recovery.

While overall profit at Rs 209.55 crore in Q1FY11 was 14.3% lower than last year same quarter, the outlook for coming quarters remains strong. The increasing contributions from existing limited competition products and 3-4 potential launches of more in 2HFY11E, analysts remain upbeat given the management guidance of $3 billion by 2013 with ROCE of 25%.

During the quarter, Dr. Reddy’s transferred dossiers and trademarks for nine currently marketed products in Brazil to GSK, for a consideration of $4 million. Other products in the pipeline have also been considered in the agreement for additional considerations on specified milestones.

The quarter also saw filings of 3 more DMF’s , 26 new product registrations and 32 generic launches strengthening the PSAI outlook and taking the total to 378 DMF’s filed till June 2010. Total cumulative ANDA’s filing stands at 163 with 71 still pending approvals from USFDA. Out of these, 36 are Para IV and 12 are FTF’s providing strong pipeline for future growth

Analysts at Emkay global estimate revenues of Rs 8,194 crore in FY11E growing 16.5% y-o-y with adjusted net profits of Rs 1182.8 crore growing 40%. The stock at Rs 1,365 levels trades 19.4 times FY11E and 14.5x FY12E earnings as per analyst estimates.