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Efforts on track to sustain robust launches across markets

Intensified competition impairs profitability for the quarter

* Dr Reddy’s Labs (DRRD)’s 4QFY22 result was below our expectation due to increased price erosion in the US/EU segments, lower export benefits and higher inventory provisions.

* We cut our EPS estimates by 6%/8% for FY23/FY24 to factor in: a) divestment of brands in Russia/India, b) lower volume off-take and adverse price variance in key markets of the US/ROW and c) increased opex related to transportation. We value DRRD on an SOTP basis (at 24x 12M forward base business EPS of INR192 and add an NPV of INR210 for Revlimid) to arrive at our TP of INR4,800.

* We remain positive on the stock due to its superior execution across key markets supported by the healthy pace of launches and market share gains in existing products. The controlled cost is likely to improve operating leverage and drive better profitability over the next 2-3 years. Retain BUY

Revenue growth driven by healthy ROW, India, and US performances

* DRRD’s 4QFY22 revenue rose 10.4% YoY to INR52.2b (v/s est. of INR55b). Growth was led by healthy performances across geographies and segments.

* Emerging markets (EM) sales grew 15.7% YoY to INR10b (20% of sales), led by 27% YoY growth in Russia (INR5.2b) and 20% YoY growth in CIS (INR2.3b). The ROW market declined 1% YoY to INR2.9b in 4QFY22.

* The Domestic Formulation (DF) sales rose 15% YoY to INR9.7b (18% of sales), North America (NAM) sales grew 14% YoY to INR20b (~USD263m; 38% of sales), and Europe sales rose 12% YoY to INR4.4b. (8.5% of sales), while the Pharmaceutical Services and Active Ingredients (PSAI) sales declined 5% YoY to INR7.5b (14.4% of sales) in 4QFY22.

* Gross margin (GM) contracted 280bp YoY to 50.9% on product mix change.

* EBITDA margin contracted at a lower rate of 120bp YoY to 20.2% (our est: 23.1%) due to lower R&D spends (down 40bp as a % of sales) and lower employee costs (down 120bp YoY as a % of sales) in 4QFY22.

* EBITDA grew slightly by ~4% YoY to INR10.5b (v/s est. of INR12.7b).

* DRRD incurred impairment charges of: a) INR4.3b related to lower market potential for PPC-06 and b) INR3b related to Shreveport plant assets.

* Higher tax expense resulted in a 34% YoY decline in Adj. PAT to INR3.1b (our est: INR7.7b)

* For FY22, revenue/EBITDA/Adj. PAT grew 12%/0.5%/8.4% to INR212b/ INR44.9b/INR26b, respectively.

Highlights from the management commentary

* Management remains confident of sustaining profitability in FY23E as well.

* DRRD would sustain the launch pace with 20-25 ANDA launches in FY23E.

* Effective tax rate is expected to be 26% for FY23.

* DRRD expects to grow in double digits YoY in the DF segment in FY23.

* DRRD has filed 11 products and received three approvals to date. It expects to launch seven products in China in FY23.

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