Dr. Reddy's Labs: Weak pipeline and rich valuations warrant caution

28 Jun 2023 , 10:14 AM

Recommendation: Reduce; Target price: Rs 4350

 

Dr Reddy’s FY23 annual report (Form 20-F) indicates that its Global Generics (GG) revenue growth of 18% was largely driven by new launches such as Revlimid. Excluding Revlimid sales of USD350mn, analysts of IIFL Capital Services estimate GG revenue grew only 2% in FY23 owing to tepid volume growth, even as price erosion moderated to 8% in FY23 vs 12% in FY22. Revlimid would have contributed ~750bps to overall Ebitda margins in FY23, implying ~440bps contraction in base business margins (ex-Revlimid). Reduction in NWC and overall margin expansion led to sharp improvement in OCF to USD734mn in FY23 vs USD395mn avg., over FY18-22. Although Dr Reddy’s is expanding Injectables facility and setting up new infra for its Biologics facility to propel long-term growth, analysts of IIFL Capital Services remain cautious owing to company’s weak US pipeline for FY24/25 on an ex-Revlimid basis. Despite assuming base business margins to normalize by ~250-300bps over next 2 years, analysts of IIFL Capital Services find Dr. Reddy’s to be one of the most expensive US franchise given it is trading at ~28x FY25 core EPS. Maintain REDUCE (TP Rs4,350). 

GG segment ex-Revlimid, grew only 2% in FY23, owing to tepid volume growth of 2% last year vs 12% volume Cagr over FY18-22. The only positive for the GG segment was moderation of price erosion to 8% in FY23 vs 12% in FY22, as also indicated by the reduction in chargebacks & rebates provisions to 26% of US revenue in FY23 vs 35% in FY22. Analysts of IIFL Capital Services expect Dr Reddy’s US revenue ex-Revlimid, to clock 10% Cagr over FY23-26ii, driven by Mayne acquisition and benefit from recent injectable shortages. 

India business clocked organic growth of 10% Cagr over FY20-23:

While Dr. Reddy’s overall India business clocked 15% Cagr over FY20-23, the base India business (excl. acquisitions and Wockhardt portfolio) grew at 10% Cagr, largely in line with IPM growth. The acquired Wockhardt portfolio declined 3% YoY in FY23, while Dr Reddy’s overall India volume growth was -0.5% Cagr over FY20-23. Analysts of IIFL Capital Services forecast Dr. Reddy’s India business to clock 10% Cagr over FY23-26ii, in line with overall IPM growth.

Investing in Injectables/Biologics capacities: 

Dr Reddy’s CWIP/ capital commitments of Rs9.9/8.3bn is for enhancing Injectables facility & new infrastructure at its Biologics facility, majority of which will get commissioned by FY24/25. However, progress on biosimilars pipeline has been slow till date (Pegfil approved but highly competitive; Rituximab filed with USFDA; Tocilizumab/Abatacept clinical trials ongoing).