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Strong growth

Dr Reddy’s (DRL) reported earnings ahead of our estimates, driven by higher sales growth in India and EMs, faster sequential growth in the US, and PSAI recovery. EMs including India sales were inflated by Sputnik vaccine and Favipiravir sales. We believe gross margins for the Covid drugs/vaccine portfolio would be lower than average. Despite this, gross margins for global generics were steady, indicating better product mix.

EBITDA margin expansion was higher than our estimate, given the higher sales, PSAI margin recovery, and licensing fees of Rs2.14bn. However, we believe the core business offers a strong trajectory of growth in EMs, India and the US (niche launches, gRevlimid). We expect normalized EBITDA margins (25%), backed by new launches, ramp-up in the US, and strong growth in Ems. We continue to maintain BUY, with a TP of Rs6,400 at 26x FY23E EPS + NPV of Rs400 from gRevlimed + Sputnik-V (we decreased the NPV from Rs.500 given the weak Sputnik-V).

US – strong product launch outlook

US contributed Rs19bn (+3% YoY and +9% QoQ), 33% of sales. The USD20mn increment QoQ, to USD255mn, was driven by four new launches – 3 in Canada including gRevlimid, and 1 in the US. The high single-digit price erosion continued to impact the base portfolio. It has 93 filings awaiting approval, of which 46 para IVs, 23 FTFs. Approval of gRevlimed offers a huge cash flow opportunity over 3-4 years’ settlement period. The settlement details highlight launch post Natco’s and do not specify any exit market share.

EMs and India markets contributed significantly in Q2

India accounted for 20% of sales at Rs11.4bn (up 25% YoY and 8% QoQ). Growth was driven by Sputnik-V and Covid-drugs; YoY growth excluding these was at mid-teens. DRL launched two new products in Q2. The EMs accounted for 23% of sales at Rs13bn (up 50% YoY and 42% QoQ). The growth was supported by new launches, price increases and Covid-drugs. DRL expects sustainable growth at healthy double-digits, going ahead.

Vaccine – Sputnik-V opportunity dependent on booster/export

Sputnik-V in India appears weak, given the vaccination level. Yet, export opportunity has some sheen left along with booster dose. Also, for adolescent vaccine, separate trials would be required. Management awaits data read out on Sputnik-V Light in few weeks and approval for export of vaccines in this quarter. DRL announced pricing of Sputnik-V imported doses at MRP of Rs948 + 5% GST per dose; DRL sees ROW as a future opportunity. Total Indian tie-up capacity is for 850mn doses.

Valuation and risk

DRL is better poised to scout more brand acquisition deals focused in India even beyond Wockhardt, given its strong balance sheet. Its CGMP compliance status is at best levels, USFDA audited CTO7/9, and the company has received form 483 with 8 observations – the audit was triggered as PAI. Management remains confident of addressing the form 483 within stipulated timelines. We maintain our BUY recommendation, with a target price of Rs6,400 including of NPV of gRevlimed and SputnikV. At the CMP of Rs4,670, DRL trades at 21.3x FY23E EPS of Rs219 and 18.7x FY24E EPS of Rs249.9.

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