'Brazil generics issue' costs Sanofi nearly as much as patent losses

There were so many ugly aspects to the Sanofi ($SNY) earnings report Thursday that for analysts to pick one out as particularly egregious is no small task. But because Sanofi has been investing heavily in emerging markets in recent years to help it offset revenue declines from patent expirations, a 2.3% crash in sales in those markets was a big surprise. So, analysts wanted to know: What happened? Sanofi termed it the "Brazil generics issue," a screw-up so deep that it trimmed €0.17 a share off of earnings, nearly as much as was lost from generic competition to two of its biggest drugs.

Sanofi CEO Chris Viehbacher

According to CEO Christopher Viehbacher, generic sales in Brazil are very price-sensitive. With an increase in the country's value-added tax set to kick in, Sanofi Brazil management--or shall we say former management--began discounting prices, selling forward to offset an expected fall-off in demand. But the amounts that its Medley unit sold overwhelmed demand and resulted in a bunch of drugs being returned because they couldn't be sold ahead of their expiration dates.

This is how Viehbacher explained it to analysts Thursday: "Now we had somewhat of a mess in Brazil. … As we looked and dug more into this, into Brazil, we realized that the level of inventory and trade was far beyond what one would normally and reasonably expect. … I would say inappropriately--in excess of the volumes needed to sell to satisfy sellout demand." In fact, the strategy led to a price war that became a downward spiral. "And so I mean, by the time April came along, they were certainly way over-optimistic and had gotten in too deep on this whole issue."

The excess product is beginning to clear out, he said, but it cost Sanofi €212 million in the quarter to deal with the matter and it also cost some jobs. Viehbacher said the company has replaced the management of the generics unit there as well as the head of Latin America, who was also general manager of Brazil. Viehbacher said the "Brazil generics issue" cost Sanofi €122 million in pharma sales. When its effects are stripped out of the picture, sales in emerging markets were up 5.3%.

Sanofi got heavily into Latin America in 2009 with the $660 million purchase of Medley, a large Brazilian generics maker. That came right on the heels of its buyout of Mexico's Laboratorios Kendrick. Those deals were believed to have made it the largest generics maker in Latin America. Sanofi was looking to emerging markets to offset falling revenues as blockbusters, like its Avapro and blood thinner Plavix, went off patent. But in this quarter, the €0.17 a share the mess in Brazil cost the French drugmakers was nearly as much as the €0.18 a share lost to generics after patent expirations on blockbusters.

The "Brazil generics issue" might have gotten more attention had it not been for the sheer depth of bad news in Sanofi's earnings report Thursday. Its net sales were down nearly 10% to €8 billion, or about $10.58 billion, and net income was off by 23.4% to €1.475 billion, or about $1.95 billion. It had a 7% decline in pharma sales and a 5.7% contraction in animal health.

- here's the earnings release (PDF)
- here's the earnings call transcript from Seeking Alpha