Strong margin beat
Dr. Reddy’s Laboratories’ (DRL) has reported Q1FY21 performance substantially above our estimates at the gross margin level, supported by better product mix and favorable forex movement. Total revenue grew 14.9% YoY, gross margin was up 430/450bps YoY/QoQ to 56.0% (I-Sec: 52.0%) and reported EBITDA margin at 25.2% was higher than estimated 21.0%. Adjusted PAT grew 47.4% to Rs5.8bn (ISec: Rs5.2bn). However, India revenue declined 10.1% YoY impacted by lockdown on account of COVID-19. We expect the growth momentum in branded generics business (India & EMs) to recover in coming quarters as would the steady pick-up in US. Acquisition of Wockhardt’s was completed in Jun’20 which would be an additional contribution to branded generics. Current valuations seem fair, hence, we maintain HOLD with a revised target price of Rs4,406/share.
* Strong growth in PSAI and EU generics: PSAI business segmented reported stellar growth of 88.4% driven by strong traction in API supplies, albeit on a low base. We expect current revenue trend to continue with customers focusing on diversifying API supply sources. EU generics also reported strong 47.7% growth led by new launches and high traction in volumes across markets. India sales declined 10.1% despite consolidation of Wockhardt products for ~20days in Q1FY21. The drop in sales was due to implementation of nationwide lockdown due to COVID-19. US revenue declined 8.4% QoQ to US$229mn vs estimated US$240mn. EM revenues grew 9.0% led by CIS and ROW with new launches and strong traction in volumes. Russia declined 17% with decline of patient footfalls.
* Margins surprise positively: Gross margin stood at 56.0%, up 430/450bps YoY/QoQ on back of favorable currency and better product mix. This led to 630/400bps YoY/QoQ improvement in EBITDA margin vs estimated 21%. Gross margin in global generics rose to 61.4% and that in PSAI improved to 33.4%. Gross margin has been quite volatile on quarterly basis and we expect it to remain ~54% vs 52.2% in FY20.
* Outlook: We raise our revenue/EPS estimates by 2-3/7-8% for FY21E-FY22E to factor-in higher growth in PSAI business and better gross margin. Overall, we expect revenues and earnings to grow at 13.4% and 26.3% CAGRs, respectively, over FY20-FY22E with 270bps EBITDA margin expansion. Margin expansion would be largely driven by improving revenue mix leading to higher gross margin and controlled S,G&A expenses.
* Valuations and risks: Considering fair valuation, we maintain HOLD on the stock with a revised target price of Rs4,406/share based on 24xFY22E EPS and an additional Rs115/share for Revlimid (earlier: Rs4,076/share). Key upside risks: Earlier than expected launch of Nuvaring and Copaxone and material gross margin improvement with better revenue mix. Key downside risks: regulatory hurdles and currency volatility
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