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Emerging markets/DF drive earnings

Niche launches in US/Robust show in emerging markets improves outlook; Upgrade to BUY

* Dr. Reddy’s Labs’ (DRRD) 2QFY22 results came in ahead of our estimates, driven by a strong show in Russia, Rest of the World (RoW), Domestic Formulations (DF), and license fee for the sale of US and Canada rights for Elyxyb (celecoxib oral solution). US sales remained steady despite price erosion in the base business, while PSAI performance was below expectations.

* We raise our EPS estimates by 4%/3% for FY22/23E to factor in a) faster growth in the Emerging Markets (EM), b) ramp-up in g-Vascepa, c) better prospects from China, and d) delay in Sputnik vaccine offtake due to commercial scale-up issues. We value DRRD’s base business EPS of INR210 at 12m forward P/E multiple of 25x and add INR210 per share of NPV from the g-Revlimid opportunity. Accordingly, we arrive at a price target of INR5,470 on a blended basis.

We UPGRADE DRRD TO BUY based on a) limited competition products pipeline for the US market, b) superior execution in DF and other EMs, c) cost control-driven improvement in operating leverage, d) and the stock’s attractive valuation

* COVID-related opportunities like Sputnik V in other countries (Ex-India) and Molnupiravir could act as potential triggers over the near-to-medium term.

EMs, DF, and out-licensing fee drive strong performance

* DRRD’s 2QFY22 revenues grew by 18% YoY to INR57.6b (v/s est. of INR41.4b).

* The growth was driven by the company’s performance across geographies. EM sales were up 50% YoY to INR12b (23% of sales), led by a growth of 90% YoY in the ROW markets (INR5.1b) and 44% YoY in Russia revenues (INR5.7b), while CIS revenues (INR2.2b) grew moderately by 9% YoY. India sales were up 25% YoY to INR11.4b (20% of sales), Proprietary products and other revenue grew 3x YoY to INR1.8b (3% of sales), Europe sales were up 10% YoY to INR4.1b. (7% of sales,) and US sales grew 3% YoY to INR18.9b (~USD255m; 33% of sales).

* Pharmaceutical Services and Active Ingredients (PSAI) segment’s revenues declined 2% YoY to INR8.4b (14% of sales).

* Gross margin contracted by 50bp YoY to 53.4% due to a change in product mix.

* EBITDA margin contracted at a higher rate of 170bp YoY to 23.2% on account of higher SGA expenses (up 240 bp YoY as % of sales), partially offset by lower R&D expense (down 120bp YoY as % of sales).

* EBITDA was up ~9% YoY to INR13.4b (our est. of INR9.9b).

* Adj.PAT grew 34% YoY to INR9.9b (our est:INR6.1).

* For 1HFY22, Sales/PAT grew 15%/19% to INR106b/INR15b, while EBITDA declined 4% to INR22b.

Highlights of management commentary

* The USFDA has completed site inspection at FTO7/9 and issued Form 483 with eight observations. The inspection was triggered by a product filing.

* Base business growth in the RoW markets, ex-COVID were very robust, along with good traction in the South African and LATAM markets. DRRD saw an increase in Favipiravir sales in Asia in 2QFY22.

* DRRD is exploring opportunities for Sputnik Light for adolescents, as a booster dose for any other vaccine, and for the export markets.

* The company expects results of the Molnupiravir trial in the next few weeks and could use the product to capitalise on the opportunity in countries with low vaccination rates.

Valuation and view

* We raise our EPS estimates by 4%/3% for FY22/23E to factor in a) the faster growth in the EMs, b) ramp-up in g-Vascepa, and c) license fee associated with the sale of US and Canada rights for Elyxb (Celecoxib oral solution).

* We estimate 24% earnings CAGR over FY21-23E, led by sales CAGR of 13% in NAM, 16% in DF, 21% in Europe, and 10% in PSAI.

* We value DRRD’s base business EPS of INR210 at 12m forward P/E multiple of 25x and add INR220 per share of NPV from the g-Revlimid opportunity. Accordingly, we arrive at price target of INR5,470 on a 12M forward earnings basis. We upgrade DRRD to BUY based on its niche products lined up for the US market, portfolio expansion/tapping newer regions in Europe/EMs, superior profitability, and the stock’s attractive valuation.

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