Dr. Reddy's Laboratories - 3QFY17 Result Update - Long-term Fundamentals Remain Intact; Headwinds to Persist in the Near-term - Reliance Securities

Dr. Reddy's Laboratories (DRRD) has topped our estimates in 3QFY17. EBITDA margin strongly improved by 5.9% QoQ led by a) better product-mix, b) seasonality in CIS, c) cost control measures, d) higher realization from biosimilar business, and e) favourable currency movement in Emerging Markets (EMs). This is despite higher R&D spend, continued pricing pressure in the US and no significant launches in the US during the quarter. Its US sales declined by 15% YoY, while domestic business remained muted with 2.4% YoY growth owing to demonetisation, higher base and impact of NLEM (National List of Essential Medicines). We reiterate our HOLD recommendation on the stock with a Target Price of Rs3,100.

Conference Call - Key Takeaways

- US FDA Resolution: All sites - for which DRRD received Warning Letters (WLs) - are expected to be inspected by Feb-Mar'17-end.

- US Sales: Management guides for moderate 4QFY17 owing to supply constraint for one large product and delay in key ANDA approvals from the US FDA. It expects >15 new launches in FY18E, out of which 4-5 are likely to be niche and high value ones.

- Copaxone: DRRD filed detailed response on API queries in Dec'16, while response on formulations will be filed by Mar'17.

- R&D Spend: R&D spend remained high in 3QFY17 due to further development activities in the products of XenoPort Inc. / Eisai Pharma and ANDAs acquired from TEVA Pharma. Management guides for US$25mn towards R&D in FY17 for these products.

- Proprietary Products: There was steady rise in volume of Zembrace & Sernivo with >112% & >30% QoQ rise in their prescriptions to 4,500 and 7,000 in 3QFY17.

- Biosimilar: DRRD has been progressing in line with Management's expectations in EMs. Strong biosimilar sales in EMs drove its gross margin. Management expects strong growth in biosimilar to continue, going forward.

Outlook & Valuation

We believe that DRRD's long-term fundamentals remain intact as it has been investing on high-margin complex generic segment (65% of 82 pending ANDA pipeline) in the US for future growth. It has the highest R&D spend (11.5% of sales) and Revenue per ANDA (at US$14.8) in the US against peers' average. However, we expect the stock to remain range-bound in the near-term due to pending US FDA WLs for three plants (Srikakulam, Mriyalguda & Duvvada) and further product concentration risk in the US market. Hence, we reiterate HOLD recommendation on the stock with a Target Price of Rs3,100 (19x Sept'18E EPS of Rs163).

Shares of DR.REDDY'S LABORATORIES LTD. was last trading in BSE at Rs.2975.2 as compared to the previous close of Rs. 3020.45. The total number of shares traded during the day was 24430 in over 2511 trades.

The stock hit an intraday high of Rs. 3033.45 and intraday low of 2968. The net turnover during the day was Rs. 73095485.

Source : Equity Bulls

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