Dr. Reddy's Labs: Valuations out of sync versus base business fundamentals

11 May 2023 , 11:53 AM

Recommendation: Reduce

Target Price: Rs. 4,100

Base business EBITDA margins (exRevlimid) at ~15% in Q4 and ~17% in FY23 have undershot IIFL’s expectations of ~20% margins; thereby driving 20-25% miss on Q4 EBITDA versus expectations. Key concern of analysts at IIFL Capital Services is Dr. Reddy’s thin US pipeline apart from Revlimid, as most of its critical US launches are lined up only from 2025/26. The company has also struggled to outperform IPM growth in India. Margins are unlikely to improve, without visibility on base business growth. Analysts at IIFL Capital Services have further cut their base-business margin estimates from ~20% to ~18%, leading to 9% EPS cuts for FY24/25. Despite the cut, their assumptions still factor in base-business EPS to increase from Rs. 110 in FY23 to Rs. 160 in FY25. Their revised Target Price of Rs. 4,100 (versus Rs. 4,400 earlier) implies 16% potential downside.

Revlimid has accounted for ~45% of FY23 EPS

Dr. Reddy’s US sales declined sequentially from USD370 million to USD310 million in Q4, as analysts at IIFL Capital Services estimate that Revlimid sales declined sequentially from USD135 million to USD70 million. With USD325 million sales in FY23, analysts at IIFL Capital Services believe that Revlimid contributed ~700 basis points to Dr. Reddy’s overall EBITDA margin of ~24% in FY23 and accounted for EPS of ~Rs. 90 versus Dr. Reddy’s overall EPS of ~Rs. 200 in FY23. Analysts at IIFL Capital Services expect Dr. Reddy’s Revlimid sales in FY24/25 to be USD300/350 million, as market share ramp-up will be partly offset by loss of exclusivity on the two strengths.

US growth to be driven by Mayne in FY24; expect India business to clock 10% CAGR

While management is targeting to launch 25-30 new products in the US, analysts at IIFL Capital Services expect Dr. Reddy’s base US business to grow only at 5% CAGR over FY23-25 as most critical US launches will materialize post 2025. Mayne acquisition will incrementally contribute ~10% to base US sales in FY24. Separately, Dr. Reddy’s India business has also grown only at 9% CAGR over FY20-23, underperforming IPM growth of 10% CAGR.

Base-business EBITDA margins were ~17% in FY23

(Ex-Revlimid, ex-divestment proceeds of Rs. 4.9 billion) and is unlikely to materially improve, given muted growth expectations in the US and underperformance in the domestic market. IIFL’s SOTP analysis implies that Dr. Reddy’s base US business is trading at ~15x FY25 EV/EBITDA on CMP, which is very expensive given that analysts at IIFL Capital Services usually value US businesses only at ~10-12x 2-year forward EBITDA.