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Dr. Reddy’s Lab |
Long term outlook intact; Maintain Accumulate |
ACCUMULATE
CMP: Rs 1,584 Target Price: Rs 1,750
n Revenues at Rs19bn (up 10% YoY); EBITDA at Rs3bn (up 6% YoY) and APAT at Rs2.8bn (up 16% YoY; adjusted for write-back at Betapharm in Q3FY10) were below estimates
n Revenues were driven by a) 16% growth in Global Generics & b) 24% increase in Proprietary Products business. Decline in PSAI segment impacted top line performance
n 400 bps YoY expansion in gross margins was negated by US$9mn non-recurring SGA cost leading to 51 bps YoY contraction in EBITDA margins to16%
n Cut earnings by 21% for FY11E and 10% each for FY12/FY13E; Maintain Accumulate with a revised price target of Rs1750
Revenue growth impacted by below than expected performance in Europe, CIS and Indian markets
Despite 60% YoY growth in the branded US market, 10% growth in revenue was
impacted by a) 5% decline in PSAI segment (est. 1% growth), b) Muted performance in
Russia/CIS (up 4% YoY), c) 14% growth in domestic business (est. 18% growth), and d)
18% decline in European markets (est. 12% decline) on the back of 24% reduction in
Betapharm sales (est. 17% reduction). However, in Russia, DRL’s secondary Rx sales
grew 21% YoY, above industry growth rate of 8% over 9MFY11 which is encouraging.
The decline in PSAI segment was led by subdued performance in its contract services
business. 14% growth in the domestic market was driven by 8% volume growth and 16
new launches (total of 40 new products over 9MFY11). Moreover, its bio-similar portfolio
continued to show strong traction (18% YoY growth) and the company is on-course to
launch 4th bio-similar in the domestic market. In the European markets, Betapharm
revenues were Rs1.4bn (est. Rs1.7bn) led by pricing pressures with the government
forcing another 16% rebate on drugs. The company is now looking to increase its
presence in the non-tender business as well. US generic business growth was led by
market share gains in key base products like Fexofenadine (21% MS), Omeprazole
(16% MS) and Cipro (22% MS) as well as progressive improvement in market share in
limited-competition products.
US business grows on new products and exclusivity launches
US generic revenue growth of 60% YoY to Rs4.8bn was driven by market share gains in
key base products like Fexofenadine (21% market share), Omeprazole (Rx) (16% MS) and
Cipro (22% MS) as well as progressive improvement in DRL’s market share in limitedcompetition
products like Omeprazole OTC and Tacrolimus (16% MS). Omeprazole OTC
was among the top 3 revenue-generator product for the company. Q4FY11 will witness the
first full quarter of sales from the limited competition products. Accolate (launched under
exclusivity on Nov 18th, 2010) sales were lower than expected due to the launch of AG.
Company’s second wave launches of Lansoprazole and Valacyclovir also performed well.
Going ahead, company expect its US business to ramp-up on the back of a) Gradual
improvement in the revenue of Omeprazole-OTC and generic Prograf (currently there is
only one more generic company, b) Recovery in the lost market share of generic Allegra
over the next few quarters (court hearing scheduled on Jan 31, 2011), c) Fondaparinux
(FDA inspection is over), and d) 3-4 new limited competition launches (less than 3 players)
in 2HFY11E
EBITDA margins impacted by higher non-recurring expense of US$9mn
In spite of 400bps expansion in gross margins to 55% in Q3FY11 led by better product mix,
EBITDA margins contracted by 51bps to 16% due to non-recurring SGA charge of US$9mn
this quarter. Higher SGA expenses (Rs6.07bn against our estimate of Rs5.3bn) were on
account of a) higher selling and marketing expense related to the seasonality in the
branded markets of India, b) higher OTC spend on products in CIS, c) charges related to
refinancing of the Betapharm loan, and c) higher litigation expenses on fexofenadine.
Management has indicated that these charges are non-recurring in nature. Adjusting for
such a charge, EBITDA margins show a healthy expansion of 158bps to 18.1% this quarter.
Going forward, we believe that reduction in SGA cost in Betapharm and higher uptake of
limited competition products coupled with strong momentum in India will improve the
operating performance of the company.
16% growth in APAT, below estimates
APAT for the quarter increased by 16% YoY to Rs 2.8 bn mainly driven by lower tax
provisioning (5% of PBT vs. 10% of PBT in Q3FY10). Higher R&D spent and increase in
SGA expense prevented further expansion in profits. Management has re-iterated its
guidance of US$3bn revenue and 25% ROCE by FY13E.
Branded formulation business in India and Russia poised for a strong
growth trajectory
After a subpar industry performance (due to fewer product launches and change in
domestic business strategy), Dr. Reddy (DRL) is likely to witness strong momentum owing
to a) restructuring of field operations by addressing weaker zones, b) ramp up in new
product launches including bio-similars, c) higher thrust on prescription generation leading
to higher brand sales and, d) capitalizing on existing presence in oncology, CVS and
dermatology. Moreover, company’s initiative to tap rural market (added 600 people in FY10)
is expected to gain traction from FY112 onwards. We expect the domestic business to
catch up with the industry growth rates of ~16-18% during the next 2-3 years, touching
Rs15.7bn in FY13E.
GSK alliance – imparts long term visibility
DRL’s tie-up with GSK for supplying branded products in the emerging markets imparts
long term visibility to the stock. DRL has already started its first shipment of 4 products to
Mexico, followed by Brazil and has filed over 100 dossiers in various markets under this
alliance. The full impact on revenues from this deal would be visible in the next 2-3 years,
as it will require at least two years for GSK to build sizable portfolio. The management has
guided for US$1bn revenue in FY13E from emerging markets on account of a) 18-20%
growth from India, b) 20% CAGR from CIS and c) significant contribution from GSK deal.
Gaining traction in limited competition products
Consolidation in existing products as well as new product launches is expected drive DRL’s
US revenues from US$350mn in FY10 to US$1bn in FY13E. Some of its limited competition
products already commercialized in the market are a) Lotrel (market size $500mn; 4
competitors), b) Tacrolimus (market size $500mn; 4-5 players), c) Omeprazole OTC
(current run-rate is US$1.5-2mn; expect it to go up to US$3-4mn/month), c) Prevacid
(market size $700mn; launched on 19th Oct 2011; 3 other generic players).
Potential launch of limited competition opportunities to drive earnings
momentum
§ Allegra-D-24 (market size $200mn): Management is confident of vacating PI on
Allegra-D-24. Court hearing scheduled on Jan 31, 2011. We do not expect other
competitors for next 2-3 years.
§ Fondaparinux: FDAs inspection is complete. We expect launch to happen in Q1FY12
against our earlier expectation of Q4FY11E. Alchemia (DRL’s marketing partner) has
further expanded the scope of agreement to all territories outside of North America as
well
§ Propecia (market size $700mn): We expect DRL to launch Propecia in Dec”12 with
180-day exclusivity (DRL is the sole filer).
Unfolding of Para IV opportunities – extend visibility beyond FY12E
DRL has built a sizeable Para IV pipeline of 32 products, of which 19 are FTFs. Some of the
opportunities likely to materialize in the near term are Exelon, Clarinex, Zyprexa,
Ibandronate and Geodon. We are of the view that DRL will be able to monetize a sizeable
portion of its Para IV and limited competition opportunities in the next 18-24 months. The
probability of monetizing these opportunities is reasonably high as historically, even in
adverse cases, DRL has been able to settle its litigation effectively.
We expect potential upside from these opportunities to be the key upgrade triggers for the
company. For valuation purpose, we have considered NPVs of products that have a higher
probability of getting monetized.
Refer our Q2FY11 Result Update detailing Un-folding of Para-IV / One-off opportunities
Cut earnings estimates to factor-in delayed Allegra launch, rise in SGA and
R&D spend; execution of limited competition opportunities remains the key
We cut our earnings estimates for FY11 and FY12 to account for higher SGA and R&D
spend and to incorporate the opportunity loss from Allegra-D (case hearing scheduled on
Jan 31, 2011) and Fondaparinux (FDA inspection of partners facility is over). However, we
keep our base business earnings unchanged at Rs61 and Rs79 for FY11E and FY12E,
respectively. Accordingly, our earning estimates are revised downwards by 21% for FY11E
and 10% for FY12E.
Our revised target price of Rs1750 (earlier Rs1763) incorporates multiple of 21x assigned to
the base business EPS. We have revised downward NPV of Para-IV/limited competition
opportunities. Management has guided for US$3bn in revenues and RoCE of 25% by
FY13E. However, as of now, they have a revenue visibility of US$2.7bn. At CMP of
Rs1584, the stock is trading at 16x FY12E earnings.
Key downside risks to our valuation:
§ Unfavourable verdict in Allegra D-24 litigation
§ Slower than expected ramp-up in generic Prilosec OTC and delay in launch of generic
Arixtra
§ Adverse healthcare reforms in Russia impacting sales performance
§ Unfavourable currency movements
§ Higher proportion of products falling under DPCO
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