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* Adj. for divestment of brands in the domestic formulation (DF) segment, Dr. Reddy’s Labs (DRRD) recorded in-line sales in 4QFY23. However, it posted lower-than-expected EBITDA/PAT due to higher opex. DRRD delivered the highest-ever annual earnings in FY23, led by strong traction in g-Revlimid.

* We reduce our earnings estimates for FY24/FY25 by 7%/7.5%, factoring in 1) higher SGA expenses, 2) prolonged slowdown in the CIS business, and 3) some price erosion in export markets. We continue to value DRRD’s base business at 22x 12M forward earnings and add INR170 as NPV of g-Revlimid to arrive at a TP of INR4,500.

* While DRRD delivered 39% YoY earnings growth in FY23, we expect moderation in the earnings CAGR to 3.6% over FY23-25 due to a high base of FY23 and limited visibility of potential products to deliver growth over the next two years. We believe the valuation already factors in the earnings upside, hence we maintain our Neutral rating on the stock.

Product mix benefit offset by higher opex on YoY basis

* Adj. for divestment of brands in the DF segment, 4QFY23 revenue grew 16% YoY to INR60b (est. INR60b).

* US sales rose 27% YoY to INR25.3b (~USD313m; 40% of sales), led by new launches and favourable FX movement. India sales grew 9.6% YoY to INR10b (20% of Sales). EU sales increased 12% YoY to INR5b. (8% of sales). EM sales grew 4% YoY to INR7.8b (12% of sales). Within EM, Russia sales declined 24% YoY. CIS sales remained flat YoY as pricing benefits were offset by lower volumes. PSAI revenue grew 3% YoY to INR7.8b. (12% of sales).

* Gross margin (GM) expanded 440bp YoY to 55.3% due to higher contribution from niche launches.

* EBITDA margin expanded 170bp YoY to 21.9% (est. 24.3%) as superior GM was offset to some extent by higher SG&A (+200bp YoY as % of sales).

* EBITDA grew 25% YoY to INR13b (est. INR14.6b).

* During the quarter, DRRD also recognized an impairment charge of INR540m and government grants of INR305m.

* Adj. for the same, DRRD had PAT of INR8b (est. INR9.5b), up 24% YoY.

* FY23 sales/EBITDA /PAT grew 14%/38%/39% to INR240b/INR62b/INR41b.

Highlights from the management commentary

* DRRD expects YoY growth in NA sales in FY24 on the back of robust launch momentum.

* The intensity of price erosion in the NA market is relatively milder compared to earlier quarters of FY23.

* DRRD completed trials for biosimilar Rituximab and has filed with US/EU/UK regulatory agencies.

* It has received approval for three products in the China market till date.

* DRRD has net surplus cash of INR50b at the end of FY23.

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