Dr Reddy s Labs. CMP: INR4,214 TP: INR4,915 (+17%) Buy

Transcription

1 BSE SENSEX S&P CNX 26,838 8,112 Bloomberg DRRD IN Equity Shares (m) M.Cap. (INR b)/(usd b) 718/ Week Range (INR) 4838/2996 1, 6, 12 Rel. Per (%) -4/28/39 Avg Val, INR m 1341 Free float (%) 74.5 Financials & Valuation (INR b) Y/E MAR E 2017E Sales EBITDA Net Profit EPS (INR) EPS Gr. (%) BV/Sh. (INR) RoE (%) RoCE (%) P/E (x) P/BV (x) Estimate change TP change Rating change 29 October QFY16 Results Update Sector: Healthcare Dr Reddy s Labs CMP: INR4,214 TP: INR4,915 (+17%) Buy Results ahead of estimates; margin improvement surprising Dr Reddy s (DRRD) 2QFY16 PAT at INR7.2b (+26% YoY) was 22% ahead of estimates, driven by 590bp margin improvement in 2Q. The margin improvement was surprising as DRRD has not launched any significant product during the last six months. Revenue was in line at INR39.9b (up 11.2% YoY) on the back of resilient US sales in 2Q. US, India and EU lead in segments: US business posted 29.9% YoY growth (5% beat) on the back of sustained market share in key injectable and scale-up in Habitrol sales. India sales grew 14% YoY to INR5.5b, in line with our estimate. Europe business reported 48% YoY growth on the back of two big product launches. However, RoW business declined 24% YoY in 2Q, with Venezuela witnessing lower sales. Russia/CIS declined 18%YoY on the back of sharp currency depreciation. Highest EBITDA margin till date: 2Q EBITDA margin at 28.6% was 529bp ahead of expectation (23.3%) as gross margin improved 234bp YoY and SG&A expenses declined 1.5% YoY due to ongoing cost rationalization activities. Gross margin for global generics was 67.3% and 25.8% for the PSAI segment. Going ahead, we expect margin to normalize at 25-27% due to niche US launches (gnexium, ggleevec, gcopaxone and complex injectables) and improved operating leverage. Earnings call takeaways: (1) Improvement in SG&A is likely to be sustainable. (2) In Oct 15, customers sourcing APIs from Srikakulam plant have received rescission letter for two ANDAs. (3) No clarity on audit timeline from US FDA for Srikakulam plant. (4) To launch Gleevec after SUNP s exclusivity period is over. (5) Russia business to see revival in 2HFY16. (6) Copaxone launch likely to be delayed due to ongoing query. Valuation and view: We project 21% CAGR growth in EPS over FY15-18 driven by (1) low-competition product launches in the US, (2) improved India business, (3) stabilized Russian currency and (4) improved profitability (400bp over FY15-18). Valuation discount to large peers (12-15%) would narrow on improving growth visibility (niche US pipeline). We reiterate Buy rating on the stock with a TP of INR4,915 (23x Sep 17E P/E 12-15% discount to large peers). Key risks: Escalation of regulatory issues (API plant) and delay in US approvals. Amey Chalke (Amey.Chalke@MotilalOswal.com); Investors are advised to refer through disclosures made at the end of the Research Report. Motilal Oswal research is available on Bloomberg, Thomson Reuters, Factset and S&P Capital.

2 Result snapshot Exhibit 1: Quarterly Snapshot (Revenue mix) (INR m) 2QFY15 1QFY16 2QFY16 YoY QoQ FY15 FY16E YoY Global Generics , , North America ,723 79, Europe ,193 8, India ,870 21, Russia/CIS (18.4) ,713 15,291 (13.7) RoW (23.8) ,057 13, PSAI (7.4) ,456 25,135 (1.3) North America (46.7) 4.2 4,605 4,380 (4.9) Europe ,507 10,023 (4.6) India (64.2) ,288 2,959 (10.0) Others ,056 7, Proprietary products ,177 4, Total revenues , , Exhibit 2: Quarterly Profit and Loss statement (INR m) 2QFY15 1QFY16 2QFY16 YoY QoQ FY15 FY16E YoY Total revenues , , Cost of revenues ,786 64, Gross profit , , Gross margin (%) bp 28 bp bp SG&A expenses (1.4) (1.3) 34,482 37, % of Total Revenues (275)bp (163)bp (77)bp R&D Expenditure ,449 19, % of Total Revenues (25)bp (46)bp (37)bp EBITDA ,472 46, EBITDA margin (%) bp 236 bp bp Amortization expenses ,103 9, % of Total Revenues bp 15 bp bp Other operating income (265) (125) (320) (917) (1,900) Operating profit ,286 38, OPM (%) bp 269 bp bp Forex loss/(gain) 118 (12) 349 na (3,008.3) (1,759) 0 (100.0) Finance expenses (539) (204) (133) na (35.0) Equity in loss of affiliates (51) (49) (56) (195) (230) 18.1 PBT ,163 38, Income tax ,984 7, Effective tax rate (%) bp (92)bp (125)bp Net income - reported ,179 31, Exceptionals na na Adjusted Net Profit ,179 31, October

3 Business highlights 2Q Revenues grew 11% YoY to INR 39.9b (USD 609m, flat YoY), primarily driven by sustained traction in US business. Global Generics business growth was in line at 13.5% YoY, led by strong growth in US, India, and Europe business. PSAI business declined 7%YoY to INR5.9b (8% miss) and Innovator product segment posted 95%YoY growth (65% beat) in 2Q. North America (47% of sales): In 2Q, on constant currency basis, DRRD grew 4% YoY (1% QoQ) to USD 286m, aided by Habitrol launch (OTC brand) and sustained market share in key injectable products. DRRD has also settled for generic Gleevec and expected to launch this product after SUNP s exclusivity. However, copaxone 20mg approval could be delayed due to pending query that could take at least two quarters for DRRD to successfully reply to US FDA. Exhibit 3: Resilient US biz grew 14%YoY (in dollar terms) US sales (USD m) One-off sales (USD m) Exhibit 4: ANDA filings - quarterly trend ANDA approval ANDA filed Q FY14 2Q FY16 1Q FY14 2Q FY14 2QFY16 In 2Q, company had filed for two new products in the US, taking cumulative ANDA filings to 227. Pending ANDAs stands at 76 including 50 Para IVs of which 18 are FTFs. India (13% of sales): India business delivered double digit growth for 7 th consecutive quarter, on account of sustained improvement in the performance of the top brands. The company has successfully integrated UCB brands in 2Q. According to AIOCD, Dr Reddys growth in domestic market was at 13.6% (secondary market data) for the Jul-Sep 15 quarter, much ahead of industry growth of 12%. 29 October

4 Exhibit 5: India formulation sales improving India form. (INR m) YoY growth (%) Q FY14 2Q FY16 RoW sales including Russia/CIS (7% of sales): Sharp depreciation in Russian ruble as well as ongoing macro-economic issues (in CIS region) led to 29% YoY decline in Russia/CIS sales. (Constant currency growth 11% YoY). Increase in drug prices from the DRRD and retailers led to significant volume decline for DRRD in 1Q. However, these price hikes have been taken back, resulting in healthy constant currency growth going ahead. The company has also guided for better traction in Russia business for next few quarters. Exhibit 6: Russian sales impacted by Rouble weakness Russia form. (INR m) Exhibit 7: Constant currency growth in Russia return to 11% Constant currency growth (%) Absolute growth (%) Q FY14 2Q FY16 2Q FY14 2Q FY16 Venezuela sales contribution weakens in 2Q: Venezuela sales declined in 2Q, for 2 nd consecutive quarter. The company has been remitting funds from its Venezuelan subsidiary at official exchange rate of 6.3 bolivar/usd (CENCOEX rate). However, certain monetary assets and liabilities may not qualify for this rate have been translated at the rate of VED per USD, resulting in INR 39m loss in 2Q. Current receivables from Venezuela market stand at USD 60m v/s USD 50m in 1Q). Going ahead, The Company would calibrate its growth in this market, depending on its ability to get funds repatriated. Europe (5% of sales): DRRD registered 48%YoY growth in Europe sales at INR2.1b, driven by two product launches in 1Q (Aripiprazole and Pregabalin). The company is expected to launch few more products in coming quarters. Margins at historical high: 2Q EBITDA margins at 28.6% were 529bp ahead of expectations (23.3%) as gross margins improved 234bp YoY and SG&A expenses declined 1.4% YoY due to ongoing cost controlled efforts across the segments 29 October

5 going on since last quarter. We expect margin to normalize going ahead at 25-27% led by niche US launches (gnexium, complex injectables) & operating leverage. Exhibit 8: Gross Margin (%) Gross profit (INR b) Gross margin (%) Exhibit 9: EBITDA Margin (%) EBITDA (INR b) EBITDA margin (%) Q FY14 2Q FY16 2Q FY14 2Q FY16 Better product mix drives gross margins: Overall gross margins at 61.3% (Up 285bp YoY) were driven by better business/product mix and cost control activities at plant level. Gross margins for Global generics and PSAI segment stood at 67.3% and 25.8%, respectively. PSAI gross margins improvement was led by product mix in 2Q. Exhibit 10: Gross margin quarterly trend (Segment wise) Global generics (%) PSAI (%) Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 R&D spends remain high: R&D expense was at 11.2% of sales at INR 4.5b v/s 11.5% of sales in 2QFY15. Scale in R&D is according to plan and expected to remain at higher level due to strong product pipeline of complex generics, Biosimilars and Proprietary products. DRRD spends 12-15% of their total R&D on Biosimilar research. 29 October

6 Exhibit 11: R&D expense on increasing trend R&D cost (INR b) R&D / sales (%) Q FY14 2Q FY16 Derivative hedges stand at USD300m at INR /USD, while balance sheet hedges are at USD135m (at average rate of INR60-65/USD). Cash flow hedges in other currencies stood at RUB960m at INR1.16/RUB and EURO6m at 73.7/EUR (maturing over next 6 months). Srikakulam facility: In Oct 15, DRRD s customers, who were sourcing their APIs from Srikakulam facility, have received Rescission letter from the US FDA for non-compliance of CGMP practices. It has also highlighted that this facility has received severe 483 observations under OAI category during last inspection (in Dec 14). Since the inspection DRRD has not received any approval from this facility. The management clarified that they have completed all remedial measures for this facility and expects one more US FDA inspection in the near future. It could take few more months to get the clearance from the US FDA. Meanwhile site transfer process for key products is still on. The company has also launched one of the site transferred product Nexium in 2Q. 29 October

7 Operating metrics Exhibit 12: Key operating metrics 3QFY13 4QFY13 1QFY14 2QFY14 3QFY14 4QFY14 1QFY15 2QFY15 3QFY15 4QFY15 1QFY16 2QFY16 Revenue Mix (%) USA India Europe LatAm RoW CRAMs Innovative products Revenue Gr. (%) USA (16.8) India Europe (20.4) 1.7 (27.8) (0.9) (3.6) (3.1) (7.2) (18.6) LatAm (0.0) 8.3 (13.0) (10.0) (27.2) (36.7) (18.4) RoW (23.8) CRAMs (18.7) (29.0) (34.7) (5.6) (0.2) (7.4) Innovative products (17.3) (5.7) (16.5) (24.8) (6.6) (1.0) (28.9) (65.2) As % of sales Raw material SG&A R&D cost Tax Rate Margins (%) Gross Margins EBITDA Margins EBIT Margins PAT margins Source: Company; MOSL 29 October

8 Valuation and view Successful monetization of several niche products (gvalcyte, gdacogen) has helped DRRD achieve a formidable base in the US. With fewer new launches in the US and concerns on Russian market, FY16 would be a year of consolidation for DRRD. However, we expect upside from US portfolio and healthy domestic growth to result in 22% EPS CAGR over FY15-18E to be driven by 15% revenue growth and cumulative 400bp operating margin expansion. Our TP of INR 4,915 implies 17% upside from current levels. We value DRRD at 23x Sep 17E EPS, at 10% premium to sector average (one-year forward P/E) and at 12-15% discount to large peers due to: With stronger earnings growth of 22% CAGR (23% for larger peers) Healthy Balance Sheet (D/E: 0.3x) and return ratios (RoE at 20%) Strong product pipeline (18 FTFs, proprietary products and Biosimilars ) Key catalysts to drive stock s performance over the medium term are: Stabilisation of emerging market economies/currency, mainly Russia/CIS (12% of sales). Clearance of Form 483 issues at Srikakulam API facility Launch of key products like gcopaxone, ggleevec, etc Key risks to our investment thesis: Regulatory delays affecting key US launches, Adverse outcome of pending FDA issues (API facility) Further depreciation of Russian currency. Every 10% depreciation of Ruble hereon (vs USD) leads to 2% downgrade in EPS estimate (annualized). 29 October

9 Story in charts Exhibit 13: Formulation led sales growth (INR b) Formulations (INR b) API (INR b) Exhibit 15: US Sales to grow at 19-20% CAGR over FY15-18E Core US sales (INR b) YoY Growth (%) Exhibit 14: India formulation business DF Revenue (INR b) YoY Growth (%) Exhibit 16: PSAI business to see moderate growth ahead PSAI Sales (INR b) YoY Growth (%) FY10 FY11 FY12 FY13 FY14E FY15 FY16E FY17E FY18E Exhibit 17: EBITDA margins improving with product mix Gross Margin (%) EBITDA Margin (%) Exhibit 18: EBITDA growth to improve in FY16-17E EBITDA (INR b) Growth (%) October

10 Exhibit 19: Strong earnings growth expected ahead Core EPS (INR/ share) Exhibit 20: Rich ANDA pipeline ANDA filed ANDA pending FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E FY09 FY10 FY11 FY12 FY13 FY14 FY15 YTD Exhibit 21: R&D expense higher due to NCE research Exhibit 22: OTC share growing in Russia sales R&D expense (INR b) % of sales Rx (USD m) OTC (USD m) OTC ( % of sales ) FY10 FY11 FY12 FY13 FY14 FY15 Exhibit 23: Return ratios lower with lower margins Exhibit 24: Fixed asset turnover (x) RoE (%) RoCE (%) Gross block (INR b) Fixed Asset turnover October

11 Financials and valuations Key assumptions Segment growth (%) E 2017E 2018E USA (15.2) India Europe (18.9) (12.6) (2.0) (6.6) (9.7) Russia (10.6) (13.7) 17.2 Others PSAI 8.8 (3.7) (21.9) 6.2 (1.3) 7.8 Innovative products (28.2) Total Sales Expenses Cost of sales (%) EBITDA Margin (%) Income Statement (INR Million) Y/E March E 2017E 2018E Net Sales 74,693 96, , , , , , ,190 Change (%) Other Income 1,118 1,669 3,634 2,411 2,871 2,130 2,510 2,510 Total Expenditure 15,660 23,742 24,763 31,699 33,472 46,285 49,937 59,940 EBITDA Change (%) Margin (%) 4,147 6,254 6,237 7,085 8,103 9,224 10,729 12,440 Depreciation & Amort. 11,513 17,488 18,526 24,614 25,369 37,062 39,208 47,500 EBIT Net Interest Exp Forex (Gains)/Losses PBT after EO Expense 12,442 19,157 21,677 26,616 28,163 38,830 41,357 49,673 Tax Tax Rate (%) 12,442 19,157 21,677 26,616 28,163 38,830 41,357 49,673 Reported PAT 1,403 4,204 4,900 5,093 5,984 7,766 8,271 9,935 Adjusted Net Profit Change (%) 11,099 12,428 13,682 21,188 22,179 31,064 33,085 39,739 Margin (%) Balance Sheet (INR Million) Y/E March E 2017E 2018E Equity Share Capital Reserves 45,144 56,596 72,256 89, , , , ,100 Net Worth 45,990 57,444 73,105 90, , , , ,952 Loans 23,503 32,210 36,678 44,742 43,126 36,164 36,164 31,164 Deferred Liabilities/Tax ,669-3,310-4,013-4,013-4,013-4,013 Capital Employed 69,580 88, , , , , , ,103 Gross Block 38,359 44,064 52,958 63,444 72,011 85,071 96, ,190 Less: Accum. Deprn. 14,714 18,086 21,213 25,695 30,040 35,543 41,602 48,161 Net Fixed Assets 29,642 33,246 37,814 44,424 48,090 55,646 60,647 65,148 Investments ,558 18,131 26,384 38,871 30,262 30,262 30,262 Goodwill/Intangibles 15,246 13,529 14,021 14,697 16,430 16,227 16,227 16,228 Curr. Assets 47,560 59,179 68,751 78,664 85, , , ,775 Inventory 16,059 19,352 21,600 23,992 25,529 30,023 36,826 42,071 Account Receivables 17,615 25,339 31,972 33,037 40,755 41,301 48,040 55,706 Cash and Bank Balance 5,729 7,379 5,136 8,451 5,394 14,737 28,273 40,117 Others 8,157 7,109 10,043 13,184 13,901 16,770 19,507 24,881 Curr. Liability & Prov. 23,490 28,691 30,603 31,936 38,556 34,429 41,612 47,310 Account Payables 8,480 9,502 11,862 10,503 10,660 12,336 15,132 17,287 Other Current Liabilities 15,010 19,189 18,741 21,433 27,896 22,092 26,480 30,023 Net Current Assets 24,070 30,488 38,148 46,728 47,024 68,402 91, ,465 Appl. of Funds 69,580 88, , , , , , ,103 E: MOSL Estimates 29 October

12 Financials and valuations Ratios Y/E March E 2017E 2018E Basic (INR) EPS Cash EPS BV/Share ,173.4 DPS Payout (%) Valuation (x) P/E Cash P/E P/BV EV/Sales EV/EBITDA Dividend Yield (%) Return Ratios (%) RoE RoCE Working Capital Ratios Fixed Asset Turnover (x) Debtor (Days) Inventory (Days) Working Capital (Days) Leverage Ratio Current Ratio (x) Debt/Equity (x) Cash Flow Statement (INR Million) Y/E March E 2017E 2018E Op. Profit/(Loss) before Tax 15,660 23,742 24,763 31,699 33,472 46,285 49,937 59,940 Interest/Dividends Recd ,669 3,151 2,003 2,793 1,768 2,148 2,173 Direct Taxes Paid -1,403-4,204-4,900-5,093-5,984-7,766-8,271-9,935 (Inc)/Dec in WC -6,501-4,768-9,903-5,265-3,353-12,035-9,096-12,586 CF from Operations 8,685 16,439 13,111 23,344 26,929 28,252 34,718 39,593 (inc)/dec in FA -12,603-8,141-11,297-14,371-13,502-16,577-15,729-16,942 Free Cash Flow -3,918 8,298 1,814 8,973 13,427 11,675 18,988 22,651 (Pur)/Sale of Investments 3,531-10,936-6,573-8,253-12,487 8, CF from Investments -9,072-19,077-17,870-22,624-25,989-7,968-15,729-16,942 Change in net worth -5, , ,302 1, ,168 (Inc)/Dec in Debt 8,847 8,707 4,468 8,064-1,617-6, ,000 Other Items -1, , Dividend Paid -2,224-2,719-2,736-3,581-3,979-5,452-5,806-6,974 CF from Fin. Activity ,288 2,516 2,596-3,998-10,941-5,452-10,806 Inc/Dec of Cash ,650-2,243 3,315-3,058 9,343 13,536 11,844 Add: Beginning Balance 6,584 5,729 7,379 5,136 8,451 5,394 14,737 28,273 Closing Balance 5,729 7,379 5,136 8,451 5,393 14,738 28,273 40, October

13 Corporate profile: Dr. Reddy's Laboratories Company description Dr. Reddy's is a vertically integrated company, with presence across the pharmaceutical value chain through its core businesses of Global Generics, Pharmaceutical Services and Active Ingredients (PSAI) and Proprietary Products. Company is currently developing bio-generics and NCEs. Key focus markets include India, the US, Europe and Russia. Exhibit 34: Sensex rebased 4,500 4,000 3,500 3,000 Dr Reddy's Labs Sensex - Rebased 2,500 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Exhibit 25: Shareholding pattern (%) Jun-15 Mar-15 Jun-14 Promoter DII FII Others Note: FII Includes depository receipts Exhibit 26: Top holders Holder Name % Holding First State Investments Management(Uk) Limited, 7.9 Oppenheimer Developing Markets Fund 4.3 Blackrock Institutional Trust Company & Their 2.9 Abu Dhabi Investment Authority 1.9 Franklin Templeton Investment Funds 1.6 Exhibit 27: Top management Name Designation Satish Reddy Chairman G V Prasad Vice Chairman & MD & CEO Exhibit 28: Directors Name Satish Reddy G V Prasad J P Moreau* Anupam Puri* Omkar Goswami* Name Sridar Iyengar* Bruce L A Carter* Kalpana Morparia* Ravi Bhoothalingam* Ashok Sekhar Ganguly* *Independent Exhibit 29: Auditors Name BSR & Co LLP Sagar & Associates Type Statutory Cost Auditor Exhibit 30: MOSL forecast v/s consensus MOSL Consensus EPS (INR) forecast forecast Variation (%) FY FY FY October

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