Sell Dr. Reddys Lab - TP Rs.1700 - Emkay

Sell, Target Price Rs 1,700 Margin contraction underway

Lower US traction to keep margins under pressure: US business contributes approx. 50% of the total generic business and is a major contributor to growth in revenues and margins. Last year in FY12, US business grew by 68% and which is expected to grow by 6% in FY13 and will decline by 7% in FY14.

Moreover, 75% of the total revenues come from Generic business which has a gross margins of approx. 58% and rest comes from PSAI which has gross margins of 38%. Going ahead, PSAI is expected to grow at a faster rate than the generic segment which will lead to margin contraction. Hence we expect price multiple to contract for DRL as Generic business is the one which gives multiples to the stock.

Declining patent cliff in US: There will be sharp decline in the value of drugs going off patent and will reduce from USD26bn in CY12 to USD10bn in CY13 and companies like DRL which are heavily focused on US alone will face growth issues.

Growth to taper beyond Q1FY13: Q1FY13 will be the peak for DRL in terms of US revenues and margins on back of launch of Geodon, Plavix and Serequel in one quarter. Next big launch is lined up in January 2013 which is Propecia.

Near term catalysts largely priced-in: We expect DRL to report 14% revenue growth in FY13 and 11% growth in FY14. We expect EBIDTA margins to decline from 23.6% in FY12 to 21.7% in FY13 and 21% in FY14. Earnings will grow by 7% CAGR over FY12-14E. On back of imminent pressure on growth and margins we downgrade the stock from Hold to Sell. At current price, the stock trades at 18.2x FY13E EPS of Rs91 and 16.8x FY14E EPS of 96.

Source : Equity Bulls

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