Dr. Reddy's Laboratories - Cost base increases; valuations attractive - ICICI Securities

Dr. Reddy's Laboratories' (DRL) reported Q3FY21 performance below our estimates at the EBITDA margin level due to increased costs. Revenue grew 12.5% YoY to Rs49.3bn (I-Sec: Rs50.0bn) driven by India, EU and ROW markets. EBITDA margin at 22.8% was lower than estimated 24.0% despite recognition of US$12mn milestone income. Adjusted PAT grew 17.9% to Rs6.2bn (I-Sec: Rs6.2bn). US declined 4.9% QoQ to ~US$235mn due to pricing pressure in some key products. India revenue grew 25.6% YoY aided by acquisition of Wockhardt's portfolio (Jun'20). We expect the growth momentum in branded generics business (India & EMs) and new launches in US to continue in coming quarters supporting growth. We believe recent stock price fall has factored in weak Q3FY21 and increased cost base. Upgrade to BUY with a revised target price of Rs5,366/share.

- India remains strong, US disappoints: India sales grew 25.6% YoY with consolidation of Wockhardt products which was completed in Jun'20 and recovery in industry growth. Adjusting for Wockhardt integration growth stood at ~8% during the quarter which is still higher than the industry. However, US revenue declined 4.9% QoQ to US$235mn vs estimated US$250mn mainly due to price erosion in some key products. We believe recent launch of Ciprodex and expectation of Vascepa launch in near term would help in improving revenue run-rate. PSAI business segmented reported muted growth of 1.5% YoY due to lower volumes. EU generics reported strong 33.9% growth led by new launches and high traction in volumes. EM revenues grew 5% led by CIS and ROW with new launches and strong traction in volumes.

- Cost base increases but margins to sustain: Gross margin was stable at 53.8%, in line with estimate. However, it was aided by milestone income received for compound AUR102. However, EBITDA margin dropped 40/210bps YoY/QoQ to 22.8% (I-Sec: 24.0%) despite lower R&D spend. This was due to 260bps QoQ rise in S,G&A expenses on account of incremental costs after integration of Wockhardt portfolio, sales & marketing expenses and increase in freight charges. Gross margin has been quite volatile on quarterly basis and we expect it to remain ~54-56%.

- Outlook: Overall, we expect revenues and earnings to grow at 13.8% and 34.2% CAGRs, respectively, over FY20-FY23E with 760bps EBITDA margin expansion. Margin expansion would be largely driven by improving revenue mix leading to higher gross margin and contribution of Revlimid from FY23E. We expect the company to generate free cash flow of ~Rs64bn over the next three years.

- Valuations and risks: We lower earnings estimates by 3-6% for FY21E-FY23E to factor-in weak Q3FY21 and higher S,G&A expenses. Considering recent fall in stock price that has made valuations attractive, we upgrade it to BUY from Add with a revised target price of Rs5,366/share based on 25xFY23E EPS and an additional Rs386/share for Revlimid (earlier: Rs5,412/share). Key downside risks: delay in launching new products, regulatory hurdles and currency volatility.

Shares of DR.REDDY'S LABORATORIES LTD. was last trading in BSE at Rs.4598.65 as compared to the previous close of Rs. 4876.35. The total number of shares traded during the day was 93752 in over 13165 trades.

The stock hit an intraday high of Rs. 4916.95 and intraday low of 4550. The net turnover during the day was Rs. 442154658.

Source : Equity Bulls

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