PSAI, India saves the day; US generics to face more October 25, 2016 Surajit Pal surajitpal@plindia.com +912266322259 Rating Reduce Price Rs3,200 Target Price Rs2,945 Implied Upside 8.0% Sensex 28,091 Nifty 8,691 (Prices as on October 25, 2016) Trading data Market Cap. (Rs bn) 542.7 Shares o/s (m) 169.6 3M Avg. Daily value (Rs m) 1258.3 Major shareholders Promoters 25.57% Foreign 35.54% Domestic Inst. 5.69% Public & Other 33.20% Stock Performance (%) 1M 6M 12M Absolute 0.6 2.6 (23.5) Relative 2.6 (6.8) (25.8) How we differ from Consensus EPS (Rs) PL Cons. % Diff. 2017 113.2 106.4 6.4 2018 133.9 150.3 10.9 Price Performance (RIC: REDY.BO, BB: DRRD IN) Dr Reddy (DRL) reported sales, EBITDA and core PAT of Rs36.2bn (10% YoY), Rs6.2bn (45% YoY) and Rs3.1bn (60% YoY) in. While DRL s overall result was above our quarterly estimates, for them to achieve the consensus year end estimates, its sales, EBITDA and PAT are required to grow at 19.6%, 104% and 175% respectively in H2FY17E over H1FY17E. DRL also benefitted from lower sales erosion in core US generic portfolio. India formulation grew by 14.4% YoY due to better growth in acute therapy following good rains and addition of UCB sales post acquisition. Management remain cautiously optimistic about US sales on timely approval and launch of ggleevec and gpalonosetron in Q4FY17E, though we expect new headwinds from the entry of new generics in gvidaza and gnexium from Q3FY17E onwards. Management expects fall in sales of key generics (gvidaza, gvalcyte, gdivalproex) to be compensated with sales from new launches. The absence of remediation costs (around US$12m) and oneoff cost in US distribution contract with Mckesson have helped to increase EBITDA margin to 17.3% in from 12% in. While 610% value erosion in older generics has been an emerging trend in US due to strong competition, DRL s US sales benefitted from very low value erosion in its core generic portfolio. The launches of four generics especially Nitroglycerin and Omeprazole also helped in 3.5% US sales QoQ. DRL expects legal outcome on gpalonosetron in Q3FY17E though unable to guide on launchesatrisk. With new projects in biosimilar, NCEs (from Teva) and NDA products, DRL s R&D costs were 14.5% of sales in and we expect the cost to remain in 1415% in FY17E and FY18E. With no sales in Venezuela the pricing volatility in Russia continue to impact sales in ROW markets in medium term. Management has guided back ended (FY19E around) peaksales (US$50m each) of recently launched NDA molecules in US. While tax guidance has been reduced to 2023% in FY17E from 2426%, the was no visibility provided on the expected timeline for resolution on Warning Letters in the three plants including API plant in Srikakulam. We maintain Reduce and retain TP at Rs2,945 (PE 22x of FY18E) Key financials (Y/e March) 2015 2016 2017E 2018E Revenues (Rs m) 148,189 154,708 147,545 157,812 Growth (%) 12.1 4.4 (4.6) 7.0 EBITDA (Rs m) 34,101 39,088 31,660 36,297 PAT (Rs m) 22,823 20,013 18,749 22,169 EPS (Rs) 134.0 117.3 113.2 133.9 Growth (%) 5.9 (12.4) (3.5) 18.2 Net DPS (Rs) 15.0 14.9 15.4 Result Update (Rs) 4,500 3,500 2,500 1,500 Oct15 Dec15 Feb16 Apr16 Jun16 Aug16 Oct16 Profitability & Valuation 2015 2016 2017E 2018E EBITDA margin (%) 23.0 25.3 21.5 23.0 RoE (%) 22.6 16.7 13.8 14.4 RoCE (%) 14.7 13.5 11.1 12.2 EV / sales (x) 4.0 3.7 3.8 3.5 EV / EBITDA (x) 17.2 14.8 17.7 15.1 PE (x) 23.9 27.3 28.3 23.9 P / BV (x) 4.9 4.3 3.7 3.2 Net dividend yield (%) 0.5 0.5 0.5 Source: Bloomberg Source: Company Data; PL Research Prabhudas Lilladher Pvt. Ltd. and/or its associates (the 'Firm') does and/or seeks to do business with companies covered in its research reports. As a result investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of the report. Investors should consider this report as only a single factor in making their investment decision. Please refer to important disclosures and disclaimers at the end of the report
Exhibit 1: Q2Y17 Result Overview (Rs m) Y/e March YoY gr. (%) H1FY17 H1FY16 YoY gr. (%) Net Sales 36,163 40,207 (10.1) 32,447 68,610 77,935 (12.0) Raw Material 8,674 9,281 (6.5) 7,564 16,238 18,133 (10.5) % of Net Sales 24.0 23.1 23.3 23.7 23.3 Personnel Cost 8,161 7,870 3.7 8,050 16,211 15,372 5.5 % of Net Sales 22.6 19.6 24.8 23.6 19.7 Others 13,058 11,731 11.3 12,931 25,989 23,235 11.9 % of Net Sales 36.1 29.2 39.9 37.9 29.8 Total Expenditure 29,893 28,882 3.5 28,545 58,438 56,740 3.0 EBITDA 6,270 11,325 (44.6) 3,902 10,172 21,195 (52.0) Margin (%) 17.3 28.2 12.0 14.8 27.2 Depreciation 2,622 2,235 17.3 2,436 5,058 4,268 18.5 EBIT 3,648 9,090 (59.9) 1,466 5,114 16,927 (69.8) Other Income 438 724 (39.5) 670 1,108 1,482 (25.2) Interest 126 215 (41.4) 148 274 496 PBT 3,960 9,599 (58.7) 1,988 5,948 17,913 (66.8) ExtraOrd. Inc./Exps. 85 57 73 158 106 Total Taxes 956 1,909 (49.9) 526 1,482 3,797 (61.0) ETR (%) 24.1 19.9 26.5 24.9 21.2 Reported PAT 3,089 7,747 (60.1) 1,535 4,624 14,222 (67.5) October 25, 2016 2
Exhibit 2: Major Sources of Revenues (Rs m) Y/e March YoY gr. (%) H1FY17 H1FY16 YoY gr. (%) PSAI (CPS & API) 5,784 5,918 (2.3) 4,692 10,476 11,532 (9.2) % of Net Sales 16.1 14.8 14.5 15.4 14.9 India 575 724 (20.6) 372 947 1,394 (32.1) % of Net Sales 1.6 1.8 1.2 1.4 1.8 International 5,209 5,194 0.3 4,320 9,529 10,138 (6.0) % of Net Sales 14.5 13.0 13.4 14.0 13.1 North America 1,135 692 64.0 643 1,778 1,272 39.8 % of Net Sales 3.2 1.7 2.0 2.6 1.6 Europe 2,095 2,426 (13.6) 1,947 4,042 4,776 (15.4) % of Net Sales 5.8 6.1 6.0 5.9 6.2 ROW 1,979 2,076 (4.7) 1,730 3,709 4,090 (9.3) % of Net Sales 5.5 5.2 5.3 5.4 5.3 Branded Formulation 28,995 32,768 (11.5) 26,638 55,633 63,729 (12.7) India 6,251 5,464 14.4 5,223 11,474 10,220 12.3 % of Net Sales 17.4 13.7 16.1 16.8 13.2 International 22,744 27,304 (16.7) 21,415 44,159 53,509 (17.5) % of Net Sales 63.4 68.4 66.2 64.7 69.1 Russia & CIS 2,790 3,900 (28.5) 5,790 7,000 (17.3) % of Net Sales 7.8 9.8 9.3 8.5 9.0 Europe 1,776 2,124 (16.4) 1,615 3,391 4,036 (16.0) % of Net Sales 5.0 5.3 5.0 5.0 5.2 North America Generics 16,134 18,563 (13.1) 15,523 31,657 37,079 (14.6) % of Net Sales 45.0 46.5 48.0 46.4 47.9 Emerging Mkt Generics 2,044 2,717 (24.8) 1,277 3,321 5,394 (38.4) % of Net Sales 5.7 6.8 3.9 4.9 7.0 Innovative Prod. (Proprietary Prod.) 1,078 1,204 (10.5) 1,015 2,093 2,207 (5.2) % of Net Sales 3.0 3.0 3.1 3.1 2.8 Net Sales 35,857 39,890 (10.1) 32,345 68,202 77,468 (12.0) October 25, 2016 3
Key takeways from conference call Management highlighted that better domestic formulation growth post good monsoon, return of stability in Russia, CMO business in Western Europe and strong offtake in US were the reason of 8% QoQ sales growth in. While the company expects value erosion in core generics to be a common feature in US, it has however benefitted from lower value erosion of core generics in. PSAI sales declined by 2% YoY, though increased by 23.3% QoQ due to strong growth in B2B revenues for US clients. With integration of UCB sales and robust growth in acute therapy drugs, domestic sales grew by 14.4% to Rs6.2bn in. Adjusted with additional sales of UCB products, the Indian formulation growth was 7% in. With expectation of lower number of approvals, DRL expects US launch of 46 products (of which 23 to have meaningful benefits) which are not dependent on Srikakulam API plant. Management guided that completion of sitetransfer for 46 key products from Srikakulam plants will help to launch key drugs such as ggleevec (in FebMar in 2017), gpropofol (H2FY17) and gxeloda (H2FY17) in near term. We however believe that probability of morethanexpected number of competitors in ggleevec, launch of gvidaza of Shilpa Medicare in H2FY17E and proposed launch of gnexium by Aurobindo in October 2016 will reduce benefits of new launches in FY17E DRL s launch of three NDA drugs is expected to gain traction in FY18E onwards though sales and promotion cots to remain high. Selling costs expected to be Rs3.2bn (10% of sales. DRL acquired 8 brands from Teva, of which one is approved while seven remain pending with USFDA. Management expects half of the pending products to be approved in H2FY18E. The approved product is expected to be launched later as per settlement with patent originator DRL submitted data and communicated with USFDA at regular intervals and completed its response on CAPA on all the three plants (for which Warning Letter issued) in January 2016. Next quality update in its plants to be completed in August 2016 and USFDA is expected to be invited for plant visit in September 2016 Capex incurred of Rs3.1bn (US$46m) and they maintain capex guidance of Rs12bn each in FY17E and FY18E and effective tax rate to be 2023% in next 24 months though effective tax rate was 24% in October 25, 2016 4
Exhibit 3: India Formulations: Sales and Growth Sales (Rs m) 7,000 1,000 4 35.0 3 25.0 2 15.0 1 5.0 Exhibit 4: US Generics (US$ m): sales and growth Sales (US$ mn) 350 300 250 200 150 100 50 12 10 8 6 4 2 2 4 Exhibit 5: Russia and CIS Sales and growth Sales (Rs m) 1,000 5 4 3 2 1 1 2 3 4 5 October 25, 2016 5
Exhibit 6: Emerging mkt: Sales and growth Sales (Rs m) 4,500 3,500 2,500 1,500 1,000 500 12 10 8 6 4 2 2 4 6 Exhibit 7: PSAI: Sales and growth (Rs m) Sales (Rs m) 1 10,000 8,000 4 3 2 1 1 2 3 4 Exhibit 8: Overall Sales and Growth Sales (Rs m) 4 40,000 3 30,000 2 20,000 1 10,000 5 4 3 2 1 1 2 October 25, 2016 6
Exhibit 9: Gross profit and Margin Gross Profit (Rs m) Margin (%) RHS 2 20,000 1 10,000 7 6 5 4 3 2 1 Exhibit 10: EBITDA and margin EBITDA (Rs m) Margin (%) RHS 1 10,000 8,000 35.0 3 25.0 2 15.0 1 5.0 Exhibit 11: R&D exps and % of sales R&D exps (Rs m) % of Sales (RHS) 1,000 16.0 14.0 12.0 1 8.0 6.0 4.0 2.0 October 25, 2016 7
Exhibit 12: PAT and growth PAT (Rs m) 9,000 8,000 7,000 1,000 10 5 5 10 October 25, 2016 8
Income Statement (Rs m) Y/e March 2015 2016 2017E 2018E Net Revenue 148,189 154,708 147,545 157,812 Raw Material Expenses 33,819 31,253 31,722 35,508 Gross Profit 114,370 123,455 115,823 122,304 Employee Cost 28,967 31,174 31,722 32,351 Other Expenses 51,302 53,193 52,441 53,656 EBITDA 34,101 39,088 31,660 36,297 Depr. & Amortization 5,722 6,874 5,852 6,346 Net Interest (1,682) 2,708 600 640 Other Income 3,927 4,343 6,523 6,781 Profit before Tax 33,988 33,849 31,731 36,092 Total Tax 5,340 7,127 5,135 5,717 Profit after Tax 28,648 26,722 26,596 30,375 ExOd items / Min. Int. 195 229 Adj. PAT 22,823 20,013 18,749 22,169 Avg. Shares O/S (m) 170.4 170.6 165.6 165.6 EPS (Rs.) 134.0 117.3 113.2 133.9 Cash Flow Abstract (Rs m) Y/e March 2015 2016 2017E 2018E C/F from Operations 25,033 41,247 22,412 41,733 C/F from Investing (22,904) (20,423) (19,716) (22,011) C/F from Financing (5,186) (21,297) (7,184) (13,146) Inc. / Dec. in Cash (3,057) (473) (4,488) 6,576 Opening Cash 8,451 5,394 4,921 432 Closing Cash 5,394 4,921 432 7,008 FCFF 18,290 19,895 5,854 18,426 FCFE 18,177 10,119 4,924 10,692 Key Financial Metrics Y/e March 2015 2016 2017E 2018E Growth Revenue (%) 12.1 4.4 (4.6) 7.0 EBITDA (%) 9.2 14.6 (19.0) 14.6 PAT (%) 6.1 (12.3) (6.3) 18.2 EPS (%) 5.9 (12.4) (3.5) 18.2 Profitability EBITDA Margin (%) 23.0 25.3 21.5 23.0 PAT Margin (%) 15.4 12.9 12.7 14.0 RoCE (%) 14.7 13.5 11.1 12.2 RoE (%) 22.6 16.7 13.8 14.4 Balance Sheet Net Debt : Equity 0.4 0.2 0.2 0.1 Net Wrkng Cap. (days) 229 221 263 248 Valuation PER (x) 23.9 27.3 28.3 23.9 P / B (x) 4.9 4.3 3.7 3.2 EV / EBITDA (x) 17.2 14.8 17.7 15.1 EV / Sales (x) 4.0 3.7 3.8 3.5 Earnings Quality Eff. Tax Rate 19.1 26.5 21.5 20.5 Other Inc / PBT 3.3 3.2 10.9 9.6 Eff. Depr. Rate (%) 8.9 8.7 6.5 6.3 FCFE / PAT 79.6 50.6 26.3 48.2. Balance Sheet Abstract (Rs m) Y/e March 2015 2016 2017E 2018E Shareholder's Funds 111,302 128,336 143,963 163,263 Total Debt 46,505 36,729 35,799 28,065 Other Liabilities (4,013) (4,230) (955) (838) Total Liabilities 153,794 160,835 178,807 190,489 Net Fixed Assets 65,282 79,668 90,602 101,918 Goodwill Investments 38,110 38,331 36,050 36,336 Net Current Assets 50,402 42,836 52,155 52,235 Cash & Equivalents 5,394 4,921 6,915 8,416 Other Current Assets 80,184 79,733 81,515 84,248 Current Liabilities 35,177 41,818 36,275 40,428 Other Assets Total Assets 153,794 160,835 178,807 190,489 Quarterly Financials (Rs m) Y/e March Net Revenue 39,679 37,734 32,447 36,163 EBITDA 10,033 4,817 3,902 6,270 % of revenue 25.3 12.8 12.0 17.3 Depr. & Amortization 2,577 2,767 2,436 2,622 Net Interest 62 170 148 126 Other Income 122 850 670 438 Profit before Tax 7,516 2,730 1,988 3,960 Total Tax 1,788 1,563 526 956 Profit after Tax 5,792 (182) 1,682 4,735 Adj. PAT 5,792 (182) 1,682 4,735 Key Operating Metrics (Rs m) Y/e March 2015 2016 2017E 2018E India Formulations 17,870 21,293 24,061 27,430 US Formulations 64,723 75,445 69,168 72,626 Russia 17,713 14,100 14,455 15,278 PSAI 25,456 22,379 19,909 20,727. October 25, 2016 9
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