Valuation has bottomed out; key products likely to drive earnings recovery; upgraded to ‘Overweight’
The risks to DRL appear well known and are discounted in the stock price. We highlight the upcoming opportunities, of which three or four key products should get monetised in the next 18 months. This should drive positive operating leverage and sharp earnings recovery. Why the anti-consensus upgrade now? What is the thesis? DRL stock is down 31% over the last 12 months and 28% YTD, underperforming the Sensex by 43ppt and 49ppt. Valuation appears to have troughed, especially EV/Sales (a relevant metric in view of margin erosion), which at 2.4x for F19e is 1 SD below the seven-year mean. Pipeline news could intensify and come to fruition in the ensuing 4-8 quarters – gCopaxone 20mg approval by H118; probable launches for gNuvaring and gSuboxone by mid-2018, depending on first-to-file (FTF) positioning; gAloxi over the next few months, and gCopaxone 40mg by 2019.
Stock price drivers: Higher-margin sales growth leading to positive operating leverage is the key to earnings recovery, which should drive the shares over the next few quarters. Our new price target of `3,133 (40% upside potential) reflects an unchanged target multiple of 20x. We roll valuation forward to our EPS estimate for the 12 months ending September 2019. Our FY19 and FY20 EPS estimates are 10.3% and 11% ahead of the Street. Big picture – the US pipeline has strengthened significantly over the last three years quantitatively (99 pending approvals vs. 68 in FY15) and qualitatively (63% are complex OSD/non-OSDs). Specialty products and biosimilars can unlock value over the longer term. Key risks: Three of DRL’s manufacturing sites have pending US FDA issues – Duvada (13 open Form 483s), Srikakulam (two open 483s), Bachupally (11 483s), and the UK (three 483s). Key US launches are contingent on FDA approval (higher bar owing to technical complexity), IP resolution, and competitors’ action, especially FTF applications blocking DRL’s launch. Rise in R&D spending to fund proprietary pipeline and INR/USD are the other key risks to our thesis. DRL has some de-risking in place via third-party manufacturing of key products.