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Emerging markets and PSAI drag performance to some extent

* Dr. Reddy’s Lab (DRRD) delivered better-than-expected 2QFY24, driven by higher North America (NA)/Europe sales and improved profitability. This was, however, offset to some extent by the subdued performance in emerging markets and Pharmaceutical services (PSAI) segments.

* We raise our earnings estimates by 6%/4% for FY24/FY25, factoring in: a) better traction in existing products and sustained launch momentum in the NA market, and b) superior growth in the European market. We value DRRD at 22x 12M forward earnings and add NPV of INR110 related to g-Revlimid to arrive at our TP of INR5,400.

* After a strong 31% earnings CAGR over FY21-23, we expect earnings growth momentum to moderate to 12% CAGR over FY23-25 due to the high base on account of g-Revlimid and gradual recovery in EM/PSAI sales. Further, the current valuation adequately factors in the earnings upside. Reiterate Neutral.

Superior product mix benefit offset by higher SG&A spending YoY

* DRRD’s 2QFY24 revenue grew 9% YoY to INR69b (our est: INR67b). Sequentially, its sales stood stable for the quarter.

* The US sales rose 13% YoY to INR32b (~USD382m; 46% of sales), led by better traction in the existing portfolio, Mayne integration, and favorable FX movement. The EU sales jumped 26% YoY to INR5.3b (8% of sales). India sales grew 3% YoY to INR12b (17% of sales). The PSAI segment’s revenue was up 9% YoY to INR7b (10% of sales). The EM sales stood flat YoY to INR12b (17% of sales). The business was hurt by currency devaluation (Russia), reduced volume off-take in CIS, and pricing pressure on the base portfolio in ROW.

* Gross margin (GM) expanded 110bp YoY to 58.7% due to a better product mix. The global generic/PSAI segments reported GM of 63.6%/17.8% in 2Q.

* EBITDA margin expanded at a lower rate of 40bp YoY to 29.0% (our est: 27.2%) due to higher SG&A/R&D spending (50bp/20bp YoY as a % of sales).

* Assuming USD110m sales from g-Revlimid and adjusting for the same, DRRD would have sales/EBITDA of INR60b/INR11b with an EBITDA margin of 19% for the quarter.

* EBITDA grew 11% YoY to INR20b (v/s est. of INR18b).

* Adj. for a one-time litigation settlement income (INR980m), DRRD reported a PAT of INR13.3b (our est: INR11.7b), up 17% YoY in 2QFY24.

* For 1HFY24, Revenue/EBITDA/PAT grew 21%/43%/37% YoY to INR136b/ INR40b/INR27b.

Highlights from the management commentary

* Management guided for 25-30 launches in FY24 and about 65-70 launches over the next three years.

* DRRD will launch b-Rituximab through a partner in FY25. The biosimilar portfolio launch (without a partner) would commence from FY27 onwards.

* Adjusting for the impact of NLEM and discontinued products, India segment grew in mid-single-digit YoY for the quarter.

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