1. Buy rating on Dr Reddy’s Lab: Revenue in line; EBITDA/PAT miss

Buy rating on Dr Reddy’s Lab: Revenue in line; EBITDA/PAT miss

Dr Reddy’s Q3FY16 results missed our Ebitda/PAT estimates by 6%/16%. Revenue growth at 3% y-o-y was largely in line with our expectation.

By: | Updated: February 15, 2016 12:15 AM

Dr Reddy’s Q3FY16 results missed our Ebitda/PAT estimates by 6%/16%. Revenue growth at 3% y-o-y was largely in line with our expectation. The US business recorded a $23m q-o-q increase, due to a pick-up in year-end injectable sales. India recorded 34% growth y-o-y on the back of the UCB acquisition. EM market sales were lower 26% y-o-y, due to adverse currency movements. PSAI (pharmaceutical services and active ingredients) revenues at R5 bn was down 17% y-o-y. SG&A costs were higher, due to $5.6m charge related to a litigation settlement and ongoing remediation efforts. This is to a large extent negated by lower R&D spend, due to receipt of share development costs for the biosimilar partnership with Merck Serono. The near-term outlook (Q4FY16) is challenging, due to EM currency depreciation and expected lower sales in the US. Management expects a pick-up in US approvals in FY17F. We remain positive and believe that the current weakness in the stock presents an opportunity to accumulate. The stock, we believe, has largely factored in the impact of EM currency headwinds and remains unexcited on US growth prospects. Pick-up in US approvals can have a material impact on earnings, in our view.

US business: Injectables portfolio supports growth—US sales were at $293m vs. $270m in Q3FY15, in line with our expectation. The sales growth was primarily driven by Dr Reddy’s injectables portfolio (year-end stocking in the US), gValcyte, and Habitrol.

reddy

US pipeline/outlook: Management sounded positive on FDA approvals

The company has 82 ANDAs/ NDAs pending for approval. It made four filings during the quarter, including one high-value injectable and one softgel. Management expects a pick-up in approvals in FY17F. gDiprivan (propofol) approval is expected in the near future, as per management. Significant progress has been made with respect to gCopaxone, and the company may respond to the CRL in the next four to five months. The company is undertaking site transfer of products that were affected (including gGleevec) by the FDA warning letter. In the near term, there is headwind of additional competition in gValcyte, as per management.

Progress on remediation efforts with respect to USFDA warning letters

Dr Reddy’s is developing and concurrently implementing CAPA (corrective action/preventive action) improvements at all the three facilities that received warning letters from the US FDA. Implementation of CAPA is likely to be in place in the next three to six months. The company provided an update to the US FDA on Jan 2016 regarding its progress in remediation of the observations raised by the FDA.

NDA approvals: Management maintains expectation of $50-70m in sales from first set of approvals. Dr Reddy’s received approval for three of its proprietary products. It expects to commercialise ZEMBRACE SymTouch (sumatriptan succinate) Injection and SERNIVO (betamethasone dipropionate) Spray by 1QFY17. Our reports DRRD receives FDA approval for Sernivo and DRRD gains NDA approvals analyse the market potential for these products. Management maintains its expectation of $50-70m in sales from first set of approvals.

India: Adjusted sales growth

at 19% y-o-y

India business delivered strong sales growth during the quarter at 34% y-o-y. As per management, India sales excluding the UCB portfolio and the spillover impact from last quarter recorded growth of 19%. This was driven by a better product portfolio mix (increase in chronic therapy contribution) and good onground execution. Management expects to sustain growth ahead of the broader market.

Venezuela: Currency headwinds; the business currently contributes ~8% of net profit. Venezuela contributed $18m in revenues during the quarter. We believe that the company has been shipping $6-7m per quarter in the past nine months. Venezuela business contributed R1.5 bn in net earnings over 9mFY16. The overall outstanding in Venezuela is $60.7m, up from $54m at the end of Q2FY16. The company has entered into contracts with government companies in Venezuela for supply of oncology biologics and other critical drugs. These supplies will be contingent on DRRD repatriating the outstanding amount.

PSAI business affected by remediation efforts: PSAI business recorded a 17% decline y-o-y due to supply disruptions related to remediation efforts and a fall in Capecitabine prices. Supplies are now back on track.

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