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Multiple one-offs hurt 1QFY23 profitability…

…but outlook remains intact in key segments

* Dr. Reddy’s Labs (DRRD) delivered in-line operational performance in 1QFY23, adjusting for the multiple non-recurring factors. Muted performances in North America (NAM), Pharmaceutical services & ingredient (PSAI) and Russia segment was offset by domestic formulation (DF) segment. Niche launches are likely to revive sales prospects for NAM from 2HFY23 onwards.

* We maintain our FY23/FY24 EPS estimates and expect 16% earnings CAGR over FY22-24, backed by: a) limited competition product launches (such as gRevlimid in 2HFY23), b) steady industry outperformance in DF/Russia segment, c) revival in PSAI segment (through new launches/catering newer markets) and d) better outlook in Russia business. We value DRRD at 24x 12M forward P/E multiple for its base business and add NPV of INR210 for gRevlimid to arrive at our TP of INR5,000. Maintain BUY.

Lower opex on adjusted basis drives profitability for the quarter

* DRRD received INR2.3b income from sale of brands to JB Chemicals and Torrent Pharma. Adjusting for the same, DRRD’s 1QFY23 revenue was stable YoY at INR50b (v/s est. of INR52.3b).

* DF sales rose 4% YoY to INR11b (22% of sales); Europe sales grew 4% YoY to INR4.1b (8% of sales); NAM sales were up 2% YoY to INR17.8b (~USD230m; 36% of sales); and Emerging Market sales declined slightly YoY to INR9b (17% of sales). PSAI revenue decreased 6% YoY to INR7.1b.

* Multiple non-recurring factors (currency headwinds, elevated commodity prices, inventory-led disruption and reduced business further dragging operating leverage) adversely affected margins. Even outsourcing of ‘Cidmus’ (product acquired from Novartis) impacted margins negatively in 1QFY23

* Adjusting for the same, Gross margin (GM) contracted 130bp YoY to 51% due to change in product mix.

* EBITDA margin expanded 240bp YoY to 20.7% (our est: 19.6%) on account of reduced SGA (down 310bp YoY) and lower R&D spend (down 50bp YoY).

* EBITDA grew 14.5% YoY to INR10.3b (v/s est. of INR10.2b).

* During the quarter, DRRD also recognized present value of receivables from Indivior on settlement for Suboxone to the tune of INR5.6b.

* Adjusting for the same, PAT grew 43% YoY to INR8.2b (our est: INR7b), due to higher other income and lower tax rate.

Highlights from the management commentary

* G-Revlimid (Lenalidomide) launch with limited volume is expected in Sep’22.

* The 13% QoQ decline in NAM sales to USD230m was largely because of the increased competition in g-Suboxone and g-Vasopressin injection.

* Russia on a constant currency (CC) basis declined 14% YoY, primarily due to political turmoil and post-stocking inventory normalization in 4QFY22.

* Recent sale of brands was at an Avg. EV/sales multiples 3.5x/4.0x.

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