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Our view

Dr Reddys’ management exuded optimism on regaining earlier (~25%) margin trajectory; it emphasized that Q1 represented a timing mismatch with price erosion not offset by big launches which were towards end of quarter. Decent opportunities like Vascepa, Ertapenem would drive growth while gross margin also rebounds from one‐ off in Q1. Investment in marketing for domestic business should pay off in the quarters ahead as company focuses beyond prescription business on areas like OTC, nutrition. As US & API business revive, it can infuse confidence on margin climb back towards 23‐25% range; on the contrary, though low probability and not factored by us, lack of meaningful ramp up in US sales would be a significant drag. For now, assume US & margin performance should normalize; accordingly, we  project a moderate 6‐7% cut to FY22/23 estimates, translating into a minor 4% reduction in TP to Rs5,350 at unchanged 26x PE on FY23 EPS. We reiterate that 1 more quarter of US disappointment can make it difficult to visualize margin reaching the guided prior trajectory, opening more downside in the stock.

Result Highlights

* Higher inventory provision than usual, slow API business led to drag on gross margin

* Management indicated not seen any unusual price erosion in US; our sense is margin decline was a major disappointment stemming from lower gross margin and higher marketing, R&D investments  

* Imperative for new launches Vascepa, Ertapenem to deliver on US growth to bring back confidence on margin trajectory. 

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