Anand Rathi: Dr Reddy’s Labs Prudent model, fairly valued; initiate with Hold

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Dr Reddy’s Labs
Prudent model, fairly valued; initiate with Hold
We initiate coverage on Dr Reddy’s Laboratories (DRL) with
Hold rating and target price of `1,636 per share. We are positive
on DRL’s business model and growth prospects; however, we
are neutral on the stock, considering current fair valuations.
 Strong traction in base business. We have a strong outlook on
DRL’s base generics business (14.7% CAGR over FY10-13e) on
the back of strengthened focus on niche products in the US (17%
CAGR), strategic expansion in emerging countries (GSK deal) and
new growth strategy for the Indian market (15.3% CAGR).
 Para IV opportunities sustainable for the next 4-5 years. DRL
has built a sizeable para IV pipeline of 38 products, including 12
FTFs including Olanzapine, Fondaparinux and Lansoprazole. We
value para IV opportunities at `82 per share.
 Improving profitability and margin. We estimate 27% PAT
CAGR over FY10-13e due to strong growth in base business,
sustainable para IV opportunity and 170bps expansion in
EBITDA margin. RoCE would improve to 21.5% in FY13e from
13.6% at present.
 Valuation and risks. The stock currently trades at fair valuations
of 24.3x FY11e and 20.1x FY12e earnings, which is higher than its
past 3-year average 18-19x forward PE. We value DRL at
`1,636/share, valuing base business at `1,577 based on 20x FY12e
base business earnings and `58/share for para IV pipeline. Risks:
Currency fluctuation and delay/failure in launching para IVs.