● Jun-13 was a weak quarter for ex-US business on both sales and
margins. India sales growth was flattish, Russia grew 3% while
PSAI grew by just 6%. Price erosion on some APIs resulted in
PSAI margins declining from 30% avg to 19% - management
expects normalisation but the normal could have been set lower.
● Positive takeaway of the Jun-13 quarter was the sharp improvement
in gross margins of global generics (up 380 bp QoQ) despite weak
India and Russia, and hit on Lansoprazole. This was driven by
contribution of high margin Reclast and lower sales of finasteride.
● Our estimates are largely unchanged (except for 1Q14 miss) as
benefit of INR depreciation is offset by (1) lower PSAI margins (2)
higher R&D guidance of 8-9% (3) higher pricing policy impact of
Rs550mn in India vs. our expectation of Rs250-300 mn.
● We increase our TP to Rs2,420 (from Rs2,180) as we remove the
discount of 10% to its peers and value at 20x FY15E. DRL US
pipeline has improved with several limited competition approvals
lately (like Injectables) and several pending like Vidaza, Copaxone,
etc. DRL is now focusing on topicals, patches and inhalers.
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margins. India sales growth was flattish, Russia grew 3% while
PSAI grew by just 6%. Price erosion on some APIs resulted in
PSAI margins declining from 30% avg to 19% - management
expects normalisation but the normal could have been set lower.
● Positive takeaway of the Jun-13 quarter was the sharp improvement
in gross margins of global generics (up 380 bp QoQ) despite weak
India and Russia, and hit on Lansoprazole. This was driven by
contribution of high margin Reclast and lower sales of finasteride.
● Our estimates are largely unchanged (except for 1Q14 miss) as
benefit of INR depreciation is offset by (1) lower PSAI margins (2)
higher R&D guidance of 8-9% (3) higher pricing policy impact of
Rs550mn in India vs. our expectation of Rs250-300 mn.
● We increase our TP to Rs2,420 (from Rs2,180) as we remove the
discount of 10% to its peers and value at 20x FY15E. DRL US
pipeline has improved with several limited competition approvals
lately (like Injectables) and several pending like Vidaza, Copaxone,
etc. DRL is now focusing on topicals, patches and inhalers.
Sharp improvement in gross margins due to US launches
Despite weak performance of branded generics (India + Russia),
gross margins in Global generics increased sharply by 380 bp to
61.6%. This was driven by (1) lower contribution of low margin generic
finasteride in Jun-13 quarter and (2) contribution from Reclast
(innovator size of $350 mn and DRL current share of 38%) where
there are only two generic players (more players should enter as they
get approval).
Negatives – weak PSAI and higher pricing policy hit in India
PSAI margins dropped from 30% in previous quarters to 19% due to
price reduction of some of the APIs. Management expects PSAI to
normalise over the next three quarters but there is no one-off effect
this quarter. Therefore, we reduce our margins for PSAI. On pricing
policy impact, management expects impact of about Rs550 mn vs our
expectation of Rs250-300 mn which impacts our India sales growth
assumptions and margins. This quarter India sales growth was also
impacted by the Maharashtra trade strike (next quarter should benefit
from channel restocking).
EBITDA margin this quarter was impacted by higher R&D expense of
8.5% (40% dedicated to innovative and biosimilars) and management
expects R&D to continue at 8-9% of sales. While higher R&D expense
is not negative, there is weak monetization of biotech and innovative
spend so far, and the market may not give the benefit of higher R&D.
Dr. Reddy’s US pipeline has been improving better than expected,
and therefore we remove our 10% discount for Dr. Reddy’s target
multiple vs. the rest of the sector and increase our target price to
Rs2,420 (20x FY15E). Our estimates for FY15 are unchanged as we
move our currency assumptions from 54 to 59 for Dr. Reddy’s
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