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Robust show in FY23; but outlook subdued

We assessed the 20F annual filing of Dr. Reddy’s Lab (DRRD) to understand its FY23 segmental performance and capital utilization in further details.

* DRRD exited FY23 on a strong note driven by healthy sales growth (13.5% YoY), better profitability (460bp margin expansion) and solid earnings growth (39% YoY).

* Further, the company optimized its product offerings in India/North America by selling certain brands for INR5b and acquiring brands/products for INR12b in FY23.

* DRRD significantly improved its ROE by 600bp to 19% over FY19-23.

* We raise our earnings estimates by 4% each for FY24/FY25 to factor in the incremental opportunities in NA due to regulatory issues in peers and moderation in price erosion in the base portfolio. We value DRRD at 22x 12M forward earnings of the base business and add INR170 as NPV of g-Revlimid to arrive at our TP of INR4,680.

* As compared to 31% earnings CAGR over FY21-23, we expect only 6% earnings CAGR over FY23-25. Further, as the valuations factor in the upside adequately, we maintain our Neutral rating on the stock

Improved sales and profitability in North America boost growth in FY23

* DRRD reinforced its growth momentum in the global generics segment (GG; 87% of FY23 sales; up 18% YoY), primarily backed by the strong traction in North America (NA)’s sales (49% of GG sales, up 36% YoY). However, the other geographies (India/Russia/EU) witnessed moderation in growth due to high base in the Domestic Formulations (DF) segment and inventory normalization in the channel in Russia segment.

* The company expanded its gross margin by 400bp YoY in GG aided by superior product mix.

* The PSAI segment (12% of FY23 sales) not only declined 5% YoY but also reported contraction in gross margin (down 600bp YoY) due to lower sales base, price erosion in certain products and higher manufacturing overheads.

Investment across portfolio optimization/capacity expansion

* DRRD invested INR25b in FY23 for capacity expansion as well as inorganic asset additions. Specifically, it acquired the Cidmus brand from Novartis and generic portfolio from Mayne for a cumulative consideration of INR12b.

* Simultaneously, the company sold brands worth INR5b to optimize the offerings in the DF segment.

* DRRD optimized working capital days by ~15 in FY23 by reducing the receivable days notably.

* Niche launches in NA and normalization of inventory in the industry across major markets have driven a sharp 300bp YoY ROE expansion to 19% in FY23.

Moderation in earnings and valuations factored in; reiterate Neutral

* DRRD delivered an earnings uptrend for the second year in a row in FY23 driven by superior performance in the NA segment but offset to some extent by the decline in PSAI segment and moderate YoY growth in other geographies.

* We raise our EPS estimates by 4% each for FY24/FY25 to factor in the additional benefits of DRRD in NA due to higher inclination of customers for certain products led by regulatory concerns at manufacturing sites of its competitors.

* We expect 6% earnings CAGR over FY23-25, led by 10% sales CAGR (broadbased across key geographies) but offset by reduced profitability in certain products in the NA segment.

* We value DRRD at 22x 12M forward earnings of the base business and add INR170 as NPV of g-Revlimid to arrive at our TP of INR4,680.

* As the moderation in earnings and valuations is factored in the upside adequately, we maintain our Neutral rating on the stock.

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