DR.REDDYS LAB: Building new growth drivers:: Edelweiss

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􀂃 Stable operating margins performance
Dr. Reddy’s Laboratories’ (DRRD) Q2FY11 operating profit of INR 3.2 bn was in
line with our estimate of INR 3.17 bn with higher gross margins, from better
product mix, offsetting higher-than-estimated R&D costs. Operating margins
remain stable at 17.2% versus 17.3% in Q2FY10 (adjusted for USD 12 mn
inventory write off), but were higher than our estimate of 16.6%, primarily due
to higher other operating income. PBT of INR 3.2 bn (28% Y-o-Y) was in line
with our estimate, while adjusted net profit of INR 2.9 bn (excluding INR 49 mn
forex loss) was 8% higher than our estimate of INR 2.7 bn, primarily due to
lower tax rate of 10% versus the estimated 17%.
􀂃 Robust performance in India and Russia offset lower PSAI sales
Net sales at INR 18.7 bn grew 2% Y-o-Y, marginally below our estimate of INR
19 bn. This miss was largely due to lower PSAI sales, offset by robust growth in
India and Russia. PSAI sales declined 14% Y-o-Y to INR 4.6 bn, 22% lower than
estimated INR 5.9 bn, impacted by price erosions and lower order flow. Ex-PSAI,
net revenues at INR 13.6 bn (versus our estimate INR 12.8 bn) grew 8% Y-o-Y
with continued higher growth in Russia and India (21% Y-o-Y). US generics
business depicted strong sequential growth of 13%, led by market share gains in
base business and new products like generic lotrel and tacrolimus launched in
Q1FY11. Betapharm sales have stabilized and grew 23% Q-o-Q; they, however,
declined 27% Y-o-Y from one-time seasonal vaccine sales in Q2FY10.
􀂃 Revising estimates to factor in higher branded generics sales
We are revising our FY11/12 estimates by (1)-5%, factoring in higher branded
formulation sales in Russia/India, offset by lower PSAI sales. We also make
adjustments for exclusivities in US business, decreasing our estimates for
generic Allegra 24D/fondaparinux in FY11, offset by launch of generic Prevacid,
and also adjust for lower tax rates expected in FY11. We highlight that sales are
expected to see sequential momentum on the back of increased traction in
Omeprazole OTC, new approvals in US and fresh tenders in Germany. Recovery
in PSAI business would be crucial for top-line growth in the near term.
􀂃 Outlook and valuations: Pricing in perfect execution; maintain ‘HOLD’
We are increasing our SOTP based value to INR 1,625 (INR 1,375 earlier),
valuing the base business (ex exclusivities) at 20x FY12E EPS. We assign INR 33
per share to one-off non-recurring opportunities. Management reiterates its
overall guidance of USD 3 bn of revenues in FY13, which will be key support to
valuations in the near term, in our view. However, current price factors in
perfect execution. We maintain ‘HOLD/Sector Performer’ on the stock.