: price: EPS: How does our one year outlook change? We maintain rating on DRRD post the company s 3QFY16 results Revenue growth for the quarter was muted (3% yoy) due to disappointing performances in Russia & CIS (-16% yoy impacted by RUB depreciation), RoW (-38% yoy on account of decline in Venezuela sales) and PSAI (-17% yoy, impacted by Warning Letters). Growth in domestic formulations (34% yoy) was aided by consolidation of acquired UCB product portfolio and strong base business growth DRRD has responded to the WL for its 3 facilities in Dec 2015 and has submitted an update to the USFDA in Jan 2016. The company has appointed Lachman Consultants to oversee the remediation process At of, Dr Reddy s trades at 20x and 17x our FY17E and FY18E earnings, respectively. We remain positive on the company s pipeline of complex generics, biosimilars and 505b(2) products. However, the risk of Import Alert, uncertainties around product launches and protracted resolution timelines should weigh on the stock in the near to medium term. Maintain with a target price of (18x FY18E EPS) How does our 3 year Outlook change? DRRD s focus, from a filings standpoint, is shifting more towards complex generics. Complex injectables is a key focus area for the company. Currently, DRRD has a pipeline of 79 pending ANDAs and 3 NDAs with complex products accounting for more than 50% of the pipeline. DRRD is the best-positioned Indian player to tap the biosimilar opportunity which is expected to drive the next phase of growth in the generic industry. DRRD s partnership with Merck KGaA for biosimilar MAbs in regulated markets is a key growth driver in the long term In-licensed products, sales force productivity improvement and integration of recently acquired of UCB portfolio should continue to drive DRRD s India business. The sharp depreciation of RUB (vs. INR) has impacted DRRD s recent growth in Russia. However, we expect Russia to remain an important market for DRRD in the long-term Key estimate revision Financial summary Year 3QFY16 Update Promoters 25.6 Institutions 56.2 Public 18.2 1m 3m 12m DRRD -2% -15% -5% Sensex -4% -8% -15% BSEHC -3% -5% 5% Revenues FY17E EBITDA margin % PAT FY18E Old New Change Old New Change Revenues 176,395 172,861-2.0% 199,094 193,886-2.6% EBITDA 42,976 41,684-3.0% 50,321 48,901-2.8% Margin (%) 24.4% 24.1% 25.3% 25.2% PAT 27,157 25,749-5.2% 31,606 30,633-3.1% EPS (Rs.) 158.9 150.6-5.2% 184.9 179.2-3.1% All figures in Rs. mn, except EPS, which is in Rs. Bloomberg Shares o/s Market Cap Feb 10 th, 2016 DRRD IN 171mn Rs. 505bn 52-wk High-Low Rs. 4,387-2,750 3m Avg. Daily Vol Index Rs. 2,325mn BSE SENSEX EPS (Rs.) PE (x) ROE (%) FY15 148,189 22.6% 21,984 128.6 23.0 21.8% FY16E 157,300 26.0% 24,635 144.1 20.5 20.2% FY17E 172,861 24.1% 25,749 150.6 19.6 18.0% FY18E 193,886 25.2% 30,633 179.2 16.5 18.4% DR HARITH AHAMED harith@sparkcapital.in +91 44 4344 0052 KRISHNA KIRAN KONDURI krishna@sparkcapital.in +91 44 4344 0037 Find Spark Research on Bloomberg (SPAK <go>), Thomson First Call, Reuters Knowledge and Factset Page 1
Financials Quarterly financial results Rs. Mn 3QFY16 3QFY15 Source: Company, Spark Capital Research; YoY Growth 2QFY16 QoQ Growth Revenues 39,679 38,431 3% 39,890-1% COGS (16,089) (16,079) 0% (15,421) 4% Gross profit 23,590 22,352 6% 24,469-4% % margin 59.5% 58.2% 61.3% SGNA (12,039) (11,150) 8% (11,058) 9% R&D expenses (4,095) (4,316) -5% (4,473) -8% EBIT 7,456 6,886 8% 8,938-17% Other income 122 341-64% 320-62% Interest (expenses)/income, net (62) 1,013 NM (216) -71% One-off expenses 0 0 0 PBT 7,516 8,240-9% 9,041-17% Tax (1,788) (2,541) -30% (1,879) -5% PAT 5,728 5,699 1% 7,163-20% Minority interest & Income from associates 64 47 37% 56-99% PAT (after MI) 5,792 5,745 1% 7,219-20% Sales break up (Rs mn) Dec-15 Dec-14 yoy Sep-15 qoq US 19,417 16,819 15% 18,563 5% Europe 1,937 1,947-1% 2,124-9% India 5,805 4,328 34% 5,464 6% Russia & CIS 4,023 4,766-16% 3,944 2% RoW 2,376 3,832-38% 2,673-11% Global Generics 33,558 31,692 6% 32,768 2% PSAI 5,082 6,112-17% 5,918-14% Proprietary Products 654 386 69% 664-2% Other 385 240 60% 540-29% Net revenues 39,679 38,431 3% 39,890-1% Source: Company, Spark Capital Research R&D expenses quarterly trend 6,000 5,144 14% 5,000 3,985 3,875 4,113 4,316 4,387 4,473 13% 4,095 4,000 12% 2,979 3,000 11% 2,000 10% 1,000 9% - 8% Dec-13Mar-14 Jun-14Sep-14Dec-14Mar-15 Jun-15Sep-15Dec-15 R&D expenses (Rs. Mn) % of sales Source: Company, Spark Capital Research Page 2
Financial Summary Abridged Financial Statements (Consolidated) Key metrics Rs. mn FY14 FY15 FY16E FY17E FY18E FY14 FY15 FY16E FY17E FY18E Profit & Loss Growth ratios Revenue 132,170 148,189 157,300 172,861 193,886 Revenue 13.7% 12.1% 6.1% 9.9% 12.2% EBITDA 31,214 33,469 40,829 41,684 48,901 EBITDA 25.5% 7.2% 22.0% 2.1% 17.3% Depreciation & amortization (7,095) (8,100) (9,926) (10,962) (12,154) Adjusted PAT 20.1% 5.5% 12.1% 4.5% 19.0% EBIT 24,119 25,369 30,902 30,722 36,747 Margin ratios Other Income 3,090 3,691 3,066 3,337 3,610 EBITDA 23.6% 22.6% 26.0% 24.1% 25.2% Interest expense (1,274) (1,092) (2,461) (918) (664) Adjusted PAT 15.4% 14.5% 15.4% 14.6% 15.5% Exceptional items / Forex gain / (loss) 497 0 0 0 0 Performance ratios PBT 26,432 27,968 31,507 33,142 39,693 RoE 26.0% 21.8% 20.2% 18.0% 18.4% PAT (after minority interest and associates) 21,515 22,179 24,865 26,001 30,911 RoCE 18.0% 15.9% 16.6% 15.0% 15.9% Adjusted PAT 20,843 21,984 24,635 25,749 30,633 RoA 14.9% 13.2% 13.1% 12.6% 13.6% Balance Sheet Fixed asset turnover (x) 1.1 1.1 1.1 1.2 1.3 Net Worth 90,801 111,302 132,181 153,798 179,927 Total asset turnover (x) 0.9 0.9 0.8 0.8 0.9 Deferred Tax (3,310) (4,013) (4,013) (4,013) (4,013) Financial stability ratios Total debt 44,742 43,126 40,455 29,273 31,306 Net Debt to Equity (x) 0.1 0.0 (0.1) (0.2) (0.2) Other liabilities and provisions 21,433 27,895 29,171 31,212 33,902 Net Debt to EBITDA (x) 0.4 0.1 (0.2) (0.6) (0.9) Total Networth and liabilities 153,666 178,310 197,794 210,270 241,122 Current ratio (x) 1.8 1.8 3.3 3.2 3.2 Gross Fixed assets 129,731 138,466 149,966 145,692 158,192 Inventory and debtor days 157 163 170 170 170 Net fixed assets 59,121 64,520 66,094 67,132 67,478 Working capital days 128 137 144 144 144 Investments 806 3,850 4,080 4,332 4,610 Interest cover (x) 18.9 23.2 12.6 33.5 55.3 Cash and short-term investments 33,534 39,653 50,278 54,111 74,416 Valuation metrics Loans & advances and other assets 13,679 14,663 15,395 16,619 18,262 Fully Diluted Shares (mn) 170.7 170.9 170.9 170.9 170.9 Net working capital 46,526 55,624 61,948 68,076 76,356 Market cap (Rs.mn) 504,717 Total assets 153,666 178,310 197,794 210,270 241,122 Adjusted EPS (Rs.) 122.1 128.6 144.1 150.6 179.2 Cash Flows P/E (x) 24.2 23.0 20.5 19.6 16.5 Cash flows from Operations 19,463 25,033 28,894 29,767 33,476 EV (Rs.mn) 494,893 Capex (10,081) (15,327) (11,500) (12,000) (12,500) EV/ EBITDA (x) 15.9 14.8 12.1 11.9 10.1 Cash flows from Investing (16,620) (22,904) (9,151) (9,451) (9,757) BV/ share (Rs.) 531.9 651.1 773.3 899.8 1,052.6 Cash flows from Financing (217) (4,118) (9,118) (16,484) (3,413) Price to BV (x) 5.6 4.5 3.8 3.3 2.8 Page 3
Spark Disclaimer Rs. Dr. Reddy Lab 3 Year Price and History 5,000 4,000 3,000 2,000 1,000 0 Feb-13 Aug-13 Feb-14 Aug-14 Feb-15 Aug-15 Feb-16 Report Date Price Reco. 04/Jan/16 3,109 3,328 Add 31/Jul/15 3,913 4,087 Add 15/Jun/15 3,317 3,977 Buy 30/Oct/14 3,046 3,450 Buy 31/Jul/14 2,809 3,200 Buy 27/Jun/14 2,463 2,915 Buy 14/May/14 2,520 2,912 Buy 12/Feb/14 2,615 3,000 Buy 06/Jan/14 2,496 2,893 Buy Price Spark Capital Advisors (India) Private Limited (Spark Capital) and its affiliates are engaged in investment banking, investment advisory and institutional equities and infrastructure advisory services. Spark Capital is registered with SEBI as a Stock Broker and Category 1 Merchant Banker. We hereby declare that our activities were neither suspended nor we have defaulted with any stock exchange authority with whom we are registered in the last five years. We have not been debarred from doing business by any Stock Exchange/SEBI or any other authorities, nor has our certificate of registration been cancelled by SEBI at any point of time. Absolute Interpretation BUY Stock expected to provide positive returns of >15% over a 1-year horizon Stock expected to provide positive returns of >5% <15% over a 1-year horizon REDUCE Stock expected to provide returns of <5% -10% over a 1-year horizon SELL Stock expected to fall >10% over a 1-year horizon Spark Capital has a subsidiary Spark Investment Advisors (India) Private Limited which is engaged in the services of providing investment advisory services and is registered with SEBI as Investment Advisor. Spark Capital has also an associate company Spark Infra Advisors (India) Private Limited which is engaged in providing infrastructure advisory services. This document does not constitute or form part of any offer or solicitation for the purchase or sale of any financial instrument or as an official confirmation of any transaction. This document is provided for assistance only and is not intended to be and must not alone be taken as the basis for an investment decision. thing in this document should be construed as investment or financial advice, and nothing in this document should be construed as an advice to buy or sell or solicitation to buy or sell the securities of companies referred to in this document. Each recipient of this document should make such investigations as it deems necessary to arrive at an independent evaluation of an investment in the securities of companies referred to in this document (including the merits and risks involved), and should consult its own advisors to determine the merits and risks of such an investment. This document is being supplied to you solely for your information and may not be reproduced, redistributed or passed on, directly or indirectly, to any other person or published, copied, in whole or in part, for any purpose. This report is not directed or intended for distribution to or use by any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction, where such distribution, publication, availability or use would be contrary to law, regulation or which would subject Spark Capital and/or its affiliates to any registration or licensing requirement within such jurisdiction. The securities described herein may or may not be eligible for sale in all jurisdictions or to a certain category of investors. Persons in whose possession this document may come are required to inform themselves of and to observe such applicable restrictions. This material should not be construed as an offer to sell or the solicitation of an offer to buy any security in any jurisdiction where such an offer or solicitation would be illegal. Spark Capital makes no representation or warranty, express or implied, as to the accuracy, completeness or fairness of the information and opinions contained in this document. Spark Capital, its affiliates, and the employees of Spark Capital and its affiliates may, from time to time, effect or have effected an own account transaction in, or deal as principal or agent in or for the securities mentioned in this document. They may perform or seek to perform investment banking or other services for, or solicit investment banking or other business from, any company referred to in this report. Page 4
Disclaimer (Cont d) This report has been prepared on the basis of information, which is already available in publicly accessible media or developed through an independent analysis by Spark Capital. While we would endeavour to update the information herein on a reasonable basis, Spark Capital and its affiliates are under no obligation to update the information. Also, there may be regulatory, compliance or other reasons that prevent Spark Capital and its affiliates from doing so. Neither Spark Capital nor its affiliates or their respective directors, employees, agents or representatives shall be responsible or liable in any manner, directly or indirectly, for views or opinions expressed in this report or the contents or any errors or discrepancies herein or for any decisions or actions taken in reliance on the report or the inability to use or access our service in this report or for any loss or damages whether direct or indirect, incidental, special or consequential including without limitation loss of revenue or profits that may arise from or in connection with the use of or reliance on this report. Spark Capital and/or its affiliates and/or employees may have interests/positions, financial or otherwise in the securities mentioned in this report. To enhance transparency, Spark Capital has incorporated a disclosure of interest statement in this document. This should however not be treated as endorsement of views expressed in this report: Disclosure of Interest Statement Analyst financial interest in the company Group/directors ownership of the subject company covered Investment banking relationship with the company covered Spark Capital s ownership/any other financial interest in the company covered Associates of Spark Capital s ownership more than 1% in the company covered Any other material conflict of interest at the time of publishing the research report Receipt of compensation by Spark Capital or its Associate Companies from the subject company covered for in the last twelve months: Managing/co-managing public offering of securities Investment banking/merchant banking/brokerage services Products or services other than those above In connection with research report Whether Research Analyst has served as an officer, director or employee of the subject company covered Whether the Research Analyst or Research Entity has been engaged in market making activity of the Subject Company; Yes/ Analyst Certification of Independence The views expressed in this research report accurately reflect the analyst s personal views about any and all of the subject securities or issuers; and no part of the research analyst s compensations was, is or will be, directly or indirectly, related to the specific recommendation or views expressed in the report. Additional Disclaimer for US Institutional Investors This research report prepared by Spark Capital Advisors (India) Private Limited is distributed in the United States to US Institutional Investors (as defined in Rule 15a-6 under the Securities Exchange Act of 1934, as amended) only by Auerbach Grayson, LLC, a broker-dealer registered in the US (registered under Section 15 of Securities Exchange Act of 1934, as amended). Auerbach Grayson accepts responsibility on the research reports and US Institutional Investors wishing to effect transaction in the securities discussed in the research material may do so through Auerbach Grayson. All responsibility for the distribution of this report by Auerbach Grayson, LLC in the US shall be borne by Auerbach Grayson, LLC. All resulting transactions by a US person or entity should be effected through a registered broker-dealer in the US. This report is not directed at you if Spark Capital Advisors (India) Private Limited or Auerbach Grayson, LLC is prohibited or restricted by any legislation or regulation in any jurisdiction from making it available to you. You should satisfy yourself before reading it that Auerbach Grayson, LLC and Spark Capital Advisors (India) Private Limited are permitted to provide research material concerning investment to you under relevant legislation and regulations. Page 5