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Back in the game

* We reiterate Buy on DRL with a modestly lower TP of Rs5,525 (vs. Rs5,755 earlier) as we lower Sputnik upside to Rs140/share from Rs350 earlier. While the domestic vaccine opportunity has almost ended, the export agreement offers an opportunity.

* DRL posted an all-round beat in Q2, with revenue, EBITDA and PAT beating estimates by 13%/19%/39%. While the results had one-off positives such as licensing income and Covid product exports in emerging markets, core businesses such as US and India also did well.

* US product launch momentum is expected to accelerate in H2FY22. Management retained EBITDA margin guidance of ~25%. Increased investments in branded markets and R&D spends will be offset by higher productivity and opex leverage. ETR will be 25-26%.

* The stock is trading at an attractive valuation of 21x 1-year forward P/E vs. the historical average of 25x. We value the stock using the SOTP valuation, which implies a 22x P/E on our Dec’23E EPS, Revlimid NPV of Rs200/share and vaccine NPV of Rs140/share.

Strong execution across segments:

US revenue of US$255mn grew 3% yoy/9% qoq, driven by new launches and ramp-up in volumes of existing products, partly offset by price erosion. India growth was stronger than expected at 25% yoy, aided by Rs900mn Sputnik sales. Emerging markets recorded a sharp jump in revenue due to strong growth in the core business across geographies as well as a tender win in Russia and Favipiravir sales in other geographies. The PSAI business was flat qoq.

Upbeat guidance:

US product launch momentum is expected to accelerate in H2FY22. Management expects continued ramp-up of recently launched products in US with strong pipeline visibility for FY23. Management reiterated EBITDA margin guidance of ~25%. Increased investments in the branded markets and R&D spends will be offset by higher productivity and opex leverage.

ETR is guided to be 25-26%. Management also sounded confident about addressing 8 observations cited by the US FDA for its Vizag plant. Most of the observations relate to a specific product as the inspection was PAI, which later converted to cGMP. The export contract for Sputnik brings back the optional upside.

Long-term outlook intact:

We remain positive on DRL as we believe it has good US pipeline visibility. In addition, its steadfast focus on the India business should drive ~200bps 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:

The stock is trading at an attractive valuation of 21x 1-year forward P/E vs. the historical average of 25x. Our TP of Rs5,525 represents a P/E of 22x on Dec’23E EPS, Revlimid NPV of Rs200/share and vaccine NPV of Rs140/share. Catalysts: Limitedcompetition launches, higher growth in the branded business, and higher offtake of Sputnik V in the export markets. Downside risks: Higher-than-expected price erosion and adverse regulatory outcome.

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