Hardick Bora 4QFY13 Results Update Sector: Healthcare Dr Reddy's Laboratories CMP: INR2,026 TP: INR2,375 Buy

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1 BSE Sensex S&P CNX 19,772 5,995 Bloomberg DRRD IN Equity Shares (m) M.Cap. (INR b)/(usd b) 344/ Week Range (INR) 2,151/1,528 1,6,12 Rel. Perf. (%) -2/9/0 Financials & Valuation (INR b) Y/E March E 2015E Sales EBITDA Net Profit Adj. EPS (INR) EPS Gr. (%) BV/Sh. (INR) RoE (%) RoCE (%) Payout (%) Valuation P/E (x) P/BV (x) EV/EBITDA (x) Div. Yield (%) May QFY13 Results Update Sector: Healthcare Dr Reddy's Laboratories CMP: INR2,026 TP: INR2,375 Buy Dr Reddy s Labs (DRRD) 4QFY13 performance was above estimates. Sales (including one-offs) were up 26% to INR33.4b (v/s est INR28.7b). Excluding oneoffs, sales were up 32% to INR30.2b (v/s est INR25.7b, mainly driven by higherthan-expected sales from core US Generics, PSAI segment and Russia/CIS. EBITDA grew 12% to INR7.18b (v/s est of INR6.54b). Ex one-offs, EBITDA was up by 21% to INR5.5b (v/s est of INR4.9b) and core EBITDA margin was down 180bp YoY to 18.3% (v/s est of 19%). Core EBITDA margin was lower-than-expected due to (1) adverse sales mix on higher-than-expected contribution from PSAI segment, (2) an undisclosed amount of one-time inventory write-off taken on discontinued products and (3) OctoPlus acquisition related expenses. Reported PAT grew 66% to INR5.71b (est INR3.5b), while core PAT (excl oneoffs and settlement fee) was up 72% to INR3.54b (est INR2.33b). The company reported one-time settlement income of INR1.22b (USD22.5m) from its litigation with Nordion Inc. Core PAT growth was higher-than-estimated due to higher top line growth, other income and lower depreciation. Management refrained from giving guidance for FY14, mainly due to uncertainty in getting FDA product approvals. However, it mentioned that current stable growth in branded formulations markets of Russia/CIS and Indian and PSAI would be maintained. Management indicated scope for improvement in EBITDA margin from these levels. Tax rate guidance stands at 20-23%, with capex guidance at INR5-6b. R&D expenses would be above 7%. Traction in the US generics and sustained growth momentum in international branded formulations segment will be the key growth drivers for DRRD, going forward. While there is uncertainty on timely FDA approvals, we believe that the recently-launched products and the pipeline of 65 pending ANDAs will support growth in the US over near term. Post the higher-than-expected 4QFY13 performance, we largely retain EPS estimates for FY14E/15E. Our core estimates exclude upsides from patent challenges/low competition opportunities in the US. The stock trades at 19.7x FY14E and 17.1x FY15E core earnings. Maintain Buy. Hardick Bora (Hardick.Bora@MotilalOswal.com) 1 Investors are advised to refer through disclosures made at the end of the Research Report.

2 4QFY13 performance was above estimates driven by PSAI segment, International branded formulations and US Generics Sales (including one-offs) were up 25.6% to INR33.4b, higher than our estimate of INR Excluding one-offs, sales were up 32% to INR30.2b v/s est of INR25.76b. Core revenue was ahead of estimates due to higher-than-expected sales from PSAI segment at INR10.17b (v/s est INR7.08b), core US sales at INR8.22b (v/s est INR6.88b) and International branded formulations at INR5.84b (v/s est INR5.7b). Performance in other regions was largely in line with estimates. We estimate one-off sales in the US at INR3.2b, which is higher than our previous estimate of INR2.97b. Sales mix & EBITDA trend (INR m) 4QFY13 4QFY12 % Change 3QFY13 % Change PSAI 10,172 7, , India 1,611 1, , International 8,561 6, , Branded Formulations 9,323 7, , India 3,481 3, , International 5,842 4, , Generics 13,243 10, , North America 11,413 8, , Europe 1,830 1, , Others Total Revenues 33,400 26, , Core EBITDA above estimate, albeit with lower margins Reported EBITDA grew 12% to INR7.18b v/s estimate of INR6.54b. Excluding oneoffs, EBITDA was up by 21% to INR5.53b (v/s est of INR4.91b) and core EBITDA margin was down 180bp YoY to 18.3% (v/s est of 19%). Core EBITDA margin was lower-than-expected due to (1) adverse sales mix on higher-than-expected contribution from PSAI segment, (2) an undisclosed amount of one-time inventory write-off taken on discontinued products and (3) OctoPlus acquisition related expenses. Reported PAT grew 66.6% to INR5.71b (v/s est INR3.52b), while core PAT (excluding one-offs and settlement income) was up 72% to INR3.54b v/s our estimate of INR2.33b. Core PAT growth was higher-than-estimated due to higher top line growth, other income and lower depreciation. Other income for the quarter includes one-time settlement income of INR1.11b (USD20.5m) from a litigation with Nordion Inc. Another INR108m (USD2m) is netted of against R&D expenses for the quarter. 15 May

3 EBITDA margin trend Key takeaways from concall No specific guidance on sales growth/ebitda: Management refrained from giving any guidance on sales growth and EBITDA for FY14. This is mainly due to the uncertainty on obtaining product approvals from the US FDA. However, it indicated that growth in other key segments, i.e., branded formulations markets of India and Russia/CIS and PSAI business, will remain stable in the near future. Without giving any specific guidance, management indicated that there is scope to improve EBITDA margins, going forward. Key products and new launches to drive US growth: While there is no specific guidance shared for US generics for FY14, growth should continue to be driven by key products like Propecia, Geodon, Lipitor, Toprol XL, Boniva and Reclast, which were launched in FY13. Besides, company had earlier indicated that it was expecting approval for some key products in the oncology space. We believe these products along with new launches can support a 15%+ growth in the US market. Management indicated that one to two niche product launches each year can be expected, subject to timely approvals. EBITDA margin for 4QFY13 was impacted by (1) adverse sales mix due to higherthan-expected contribution from PSAI segment, (2) an undisclosed amount of one-time inventory write-off taken on discontinued products and (3) OctoPlus acquisition related expenses. One-time fee: Company reported one-time settlement fee from Nordion Inc, pertaining to a previous contract research arrangement with the latter. Hence, Nordion paid DRRD USD22.5m (INR1.22b), of which INR108.4m (USD2m) is netted off against R&D expenses and the balance (USD20.5m) is included in other income. Other guidance parameters: Management guided FY14 tax rate of 20-23%, with R&D expenses to be over 7% of sales, going forward. Increased R&D spend would be for niche ANDA filings in the space of injectables, delayed release products, topical etc. Company plans to file ANDAs per year going forward, with a focus on such niche products that enjoy low competition. Future hedges to realize better rates: Forex hedges stood at ~USD480m (at an average of INR56-59). While DRRD hedges forthcoming 18 months of its net exposure (and hence is reasonably hedged), we note that incremental hedges are coming at better rates. This will also aid top line growth in the US. 15 May

4 Balance sheet hedges stand at USD350m and outstanding net debt on the book is USD267m (net debt/equity at 0.2x). US generics continue to be a key market in FY14 US generics continue to be a key market for the company. Management indicated that it will be able to meet this target for the US if it receives ANDA approvals for some key launches in the pipeline. Else, it will monetize these opportunities in FY14. Unlike the consensus belief, management had earlier indicated that it is confident of achieving 10-15% CAGR in US revenue from FY14 (despite the patent cliff), led by the commercialization of its pipeline of 65 ANDAs (pending approval) and the contribution from FTF/low competition opportunities. Going forward, DRRD plans to maintain 30% of its total product filings in niche/complex molecules. We estimate 15% growth in core US revenue in FY14E over a high base in FY13. Our growth estimate factors the potential adverse impact of patent cliff and does not account for any potential upside from possible para IV/limited competition launches. We note that growth in FY14E will also be aided by realization of favorable rates on cash flow hedges (average rate of INR56-59/USD). We expect growth in FY15E to moderate at 10%. Dr. Reddy's - Core US Sales (INR M) PSAI business to report steady growth in FY14E Despite the management s cautious guidance last year, DRRD s PSAI business recorded strong growth of 34% for FY13 led mainly by higher API supplies linked to patent expiries in the US and incremental ramp-up in its CRAMS business. We believe that while this strong growth traction will moderate due to reduced number of patent expiries, FY14E will see a moderate 14% growth before tapering off to 10% in FY15E. 15 May

5 Dr. Reddy's - PSAI Sales (INR m) Branded formulations exports to sustain double digit growth; potential change in regulations, a key long term risk We expect DRRD to sustain ~20% revenue CAGR for this business over FY13-15E led by: a) Expanding presence in Russian OTC market coupled with additional growth drivers like in-licensed products. b) Ramp-up in the biogeneric portfolio in emerging markets management expects revenue of USD100m in the next two to three years v/s the current USD30m. c) Gradual ramp-up in revenue from company s partnership arrangement in emerging markets. However, the Russian market (a key contributor for DRRD s emerging markets business) is gradually transitioning from an out-of-pocket market to the model of centralized reimbursement, with the Russian government expected to play a key role in regulating both access and price of essential medicines. Currently, 55-60% of products marketed by DRRD are included in the essential drugs list. This is a key long term risk for DRRD given that it is one of the most profitable markets. Dr. Reddy's - Branded Formulation Exports (INR m) 15 May

6 India formulations business growth recovers DRRD s India formulations business faced multiple growth challenges in the past few years mainly due to execution shortfalls: a) Company redeployed its experienced urban sales force in rural areas, which resulted in a decline in urban doctor coverage and loss of business in the metros. Management stated it has taken corrective action and the results should be visible in the next few quarters. b) Further, during the last few years, DRRD s focus was on the US and Europe, post Betapharm s acquisition. India was ignored, which resulted in fewer product launches here. However, company has now resumed a healthy rate of product introductions (23/24 in FY12/FY13). c) Management had earlier indicated that it targets to match the industry growth rate of 14-15%, while FY13 growth was at 12.6%. We expect this business to record 13.5% CAGR for FY13-15E, slightly lower than the average market growth. Dr. Reddy's - Domestic Formulations growth recovering (INR m) Valuation and view Traction in the US generics and sustained growth momentum in international branded formulations segment will be the key growth drivers for DRRD, going forward. While there is uncertainty on timely FDA approvals, we believe that the recently-launched products and the pipeline of 65 pending ANDAs will support growth in the US over near term. Post the higher-than-expected 4QFY13 performance, we largely retain EPS estimates for FY14E/15E. Our core estimates exclude upsides from patent challenges/low competition opportunities in the US. The stock trades at 19.7x FY14E and 17.1x FY15E core earnings. Maintain Buy with a target price of INR2,375, 17% upside. 15 May

7 Dr. Reddy's Laboratories: an investment profile 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. Key investment arguments Reiterates strong growth traction over the coming quarters: Management expects to achieve strong growth led by the US, PSAI and emerging market and without any major inorganic growth initiatives. Company continues to focus on its five key markets - the US, India, Russia, Germany and the UK. US market will be a key contributor led by the commercialization of its pipeline of 65 ANDAs (pending approval) and the contribution from FTF/ low competition opportunities. Key investment risks Government mandated price controls could impact the profitability of India formulations business. Higher-than-expected currency appreciation could adversely impact future earnings. Recent developments Launched exclusive generic version of Propecia as expected. Received USD22.5m as litigation settlement income from Nordion Inc. Valuation and view We estimate core EPS of INR103 for FY14E and INR118.8 for FY15E. Trades at 19.7x FY14E and 17.1x FY15E core earnings. Sector view Emerging markets coupled with low competition/ Para-IV upsides in the US would remain the key sales and profit drivers in the medium term. We are Overweight on companies that have a differentiated business model for the US market. Comparative valuations DRL Cipla Ranbaxy P/E (x) FY14E FY15E P/BV (x) FY14E FY15E EV/Sales (x) FY14E FY15E EV/EBITDA (x) FY14E FY15E EPS: MOSL forecast v/s consensus (INR) MOSL Consensus Variation Forecast Forecast (%) FY FY Target price and recommendation Current Target Upside Reco. Price (INR) Price (INR) (%) 2,026 2, Buy Stock performance (1 year) Shareholding pattern (%) Mar-13 Dec-12 Mar-12 Promoter Domestic Inst Foreign Others May

8 Financials and Valuation 15 May

9 N O T E S 15 May

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