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All is well

* We maintain Buy on DRL but lower our TP to Rs5,755 from Rs5,935, as we trim FY22/23/24E EPS (excl. gRevlimid) by 6%/4%/2% to reflect the Q1 miss. In our view, the market’s reaction to the weak set of numbers is overdone and we see the current price as a good entry point.

* Q1 revenue of Rs49.1bn (+11% yoy, 4% qoq) was lower than our estimates by 2% and consensus estimates by 4%. EBITDA of Rs9bn (-19% yoy, -11% qoq) missed our estimates by 24%. The EBITDA margin of 18.3% missed our/consensus estimates by 23.7%/22.6%.

* Management has guided for a meaningful profitability improvement from Q2 and also reiterated its long-term EBITDA guidance of 25%. While higher SG&A expenses are expected to continue, increased investment in the branded markets will be more than offset by higher growth.

* The stock is trading at 20x FY24E EPS (excl. Revlimid and Sputnik V). Our TP of Rs5,755 is based on 21x P/E on FY24E core EPS (Rs246), Revlimid NPV of Rs200/share, and Sputnik V NPV of Rs350/share.

India put up a strong show; other segments largely in line:

US revenue of $236mn was in line with our estimates. India growth was stronger than expected at ~69% yoy due to the favorable impact of Covid-19 portfolio and Wockhardt acquisition. Europe at Rs3.9bn grew 12% yoy, driven by new launches. Emerging markets grew 14% yoy on increased volumes in the base business and new launches. PSAI revenue declined 12% yoy due to the price erosion in a few products.

Margins were down due to price erosion in US:

Gross margin decreased 150bps qoq due to higher price erosion in the US, inventory provisioning, and a decline in PSAI margins. Management indicated that the sharp decline in margin in Q1 was a blip. The EBITDA margin narrowed by 315bps qoq to 18.3%. It was also impacted by higher SG&A spends due to the increase in employee expenses, and investments in brand promotion and digitalization.

Profitability to improve meaningfully:

Management alluded that profitability will improve meaningfully from Q2, driven by the ramp-up of recently launched products, higher growth in the branded markets and an increase in API scale. Management also reiterated its long-term EBITDA margin guidance of 25%.

Long-term outlook intact:

We continue to remain positive on the company as we believe it has good US pipeline visibility. In addition, the company’s steadfast focus on the India business continues and should drive ~220bps growth outperformance relative to the India pharma market, along with margin expansion, as the sales force remains stable. The company’s strategy of leveraging the US portfolio for Europe and ROW is expected to drive growth and margin accretion in the medium term.

Valuations attractive:

After the sharp correction in the stock price following the result announcement, the stock is trading at an attractive valuation of 24x 1-year forward P/E vs. the historical average of 26x. Our TP of Rs5,755 represents a P/E of 21x on FY24E core EPS (Rs246), Revlimid NPV of Rs200/share, and vaccine NPV of Rs350/share. Catalysts: Limited-competition launches, higher growth in the branded business, and higher-than-expected vaccine margins.

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