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Dr Reddy’s delivered a strong 2Q much ahead of street estimates (46% PAT beat) and our estimates (36% beat). The outperformance was led by gRevlimid, PLI benefits and product mix. Their core EBITDA margins improved significantly QoQ, even excluding gRevlimid (23- 24%). Management maintains EBITDA margin guidance of 25% on a sustainable basis as we expect many levers to aid expansion (such as PSAI margin recovery) and further improvement in performance 2H onwards. 2Q has delivered steady revenues in Russia business and is expected to grow along with EU, EM and India markets. Considering better than anticipated base business margins and higher contribution from gRevlimid, we have increased our earnings estimate by 17% for FY24E. We expect increasing cash flows to strengthen the balance sheet providing sufficient headroom for inorganic acquisitions largely focused towards India and EMs. This would enable the management to concentrate and build EM business whilst reducing US concentration. With INR 13.7bn net cash surplus, DRRD focuses on Horizon 2 opportunities, biosimilars, complex Gx pipeline and growing India business. We continue to remain bullish on the stock given DRRD’s attractive pipeline, diversified business and positive earnings trajectory. We roll forward to Sep’23 Price Target of INR 5960 (including Revlimid NPV of INR 250). At CMP of INR 4460, DRRD trades at 21x/18x FY24/FY25 earnings respectively ex-Revlimid. Maintain BUY.

Revlimid-led US drives beat: US business reported sales of INR 28bn (USD 351mn; 29% beat) growing 48%YoY and 57%QoQ. The performance was driven by gRevlimid (launched all strengths in Sep’22) wherein 2 strengths have 180 day exclusivity. The management expects Revlimid sales to be higher in 3Q/4Q. DRRD launched 7 products in 2Q while launch momentum and ANDA filing is expected to further gain momentum in 2H. US base business (ex-Revlimid) expected to deliver continuous single digits growth guided by management. DRRD has an attractive US pipeline including 81 pending filings (42 Para IV, 22 FTFs) and is focusing on biosimilars. bPegfilgrastim was filed by DRRD’s partner and is also on track to file Rituxan in CY23 (key difference being Rituxan will be manufactured by DRRD).

EM, India continues to grow (ex-Covid): EM reported revenues of INR 12.2bn declining 6%YoY but grew in single digit ex-Covid. Russia and CIS reported revenues of INR 8.1bn (22% beat) as new launches, price hikes, forex movement and channel inventory normalisation contribute to growth. DRRD launched 71 products across the world. Domestic business reported INR 11.5bn revenues (in-line) growing +1%YoY (mid-teens ex-Covid). DRRD continues to focus on growing India business by divesting non-core brands, growing brands organically and evaluating inorganic opportunities. During 2Q, DRRD launched 2 products- Curaprox and Stig.

PSAI lags, recovery in sight: PSAI gross margins declined to 3.5% (ex-Covid provision was in high single digits). PSAI revenues declined 23%YoY (19% miss) to INR 6.4bn due to high Covid base and price erosion in key molecules. However, the management expects sequential improvement backed by new products launches from 2H onwards and growthin CDMO business. During the quarter, DRRD filed 2 DMFs.

Revlimid to drive earnings upgrades: DRRD launched all strengths of gRevlimid with 180 day exclusivity in 2 strengths (ending in Mar’23). The volume revision is expected in Mar’23 which will increase revenue share. Additionally, we could also see more players entering the market (like SUNP) meanwhile price erosion should be limited. DRRD expects 3Q/4Q sales to be higher than 2Q for Revlimid implying the full benefit of this drug is yet to accrue. Revlimid is generating EBITDA margins of 60-65% (Refer Exhibit 1) which is driving overall EBITDA margin of DRRD beyond 25% (while base margins remain 23- 24%). There could be volatility in terms of quarterly recorded sales although volume share is capped. Revlimid sales will begin to taper from FY26 post genericisation. We have built in a Mar’23 NPV of INR 250 for gRevlimid (revised upwards by 25%). Revlimid reported sales of USD 100-110mn in 2Q and we believe we could see similar trends in upcoming quarters.

Key Financials: Revenue/EBITDA/PAT of INR 63bn/18.9bn/11.1bn grew +9%/+42%/+12% YoY respectively and were +8%/+41%/+36% vs. our expectations and were +9%/+53%/+46% vs. street expectations. Gross margin was 59% (vs. 53.4%YoY; vs. 49.9%QoQ). EBITDA margin improved ~690bps YoY to 30% (JMFe: 23.1%). Gross margin included INR 1.9bn government grant income (including PLI incentive) and INR 1bn covid write off pertaining to all regions. Capex for the quarter was INR 2.5bn while FCFF was INR 5.8bn. Net cash surplus as at 30 Sep’22 was INR 13.7bn.

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