The company has demonstrated very effective cost control with 250bps margin expansion in FY19 and our estimates assume additional benefit of ~100bps base business margin expansion from the ongoing efforts.
Dr. Reddy’s Laboratories (DRL’s) stock price has appreciated ~10% over the last few days without any positive development and fundamental change. We believe the valuation is now overpricing the key product opportunities (Nuvaring, Copaxone etc) and cost-control benefits. The company has demonstrated very effective cost control with 250bps margin expansion in FY19 and our estimates assume additional benefit of ~100bps base business margin expansion from the ongoing efforts. However, the key concerns pertaining to (i) the recent CRLs for Nuvaring and Copaxone could delay the launch, (ii) the pending issues at the Srikakkulam API facility remain an overhang for Copaxone launch and (iii) the recent 483 observations at the Duvvada facility would restrict growth. Maintain Reduce.
Prolonged delay in key product opportunities
Generic Copaxone, Nuvaring and Suboxone are the key high-value product opportunities for DRL. However, there has been constant delay in their launches due to additional queries pertaining to the filings and litigation. They were initially expected to be launched in early FY19 but only generic Suboxone was launched in Q4FY19, with slow ramp-up in market share. We now expect launch of Nuvaring and Copaxone in H2FY21 and these three products together would contribute 10.5/11.0/15.6% of total EPS in FY20e/FY21e/FY22e. We believe delay in approvals for the two products would reduce the opportunity size for the company with increasing competition and earnings begin to drop.
US sales growth and cost-control benefits already priced in
Excluding the key product opportunities, we expect 5.1% CAGR in base US sales to $1 bn over FY19-FY22e. Slower growth is due to a continuous price erosion of ~5% in base portfolio and increasing competition in other key products like generic Dacogen, Toprol XL, etc. New launches of 10-15 products per year and recent acquisition of 42 ANDAs (abbreviated new drug applications) in US including 30 injectables would support growth. The company has successfully demonstrated efficient cost-control exercises which helped in 250bps Ebitda margin improvement in FY19 and we estimate additional improvement of ~100bps over FY19-FY22e.
We largely maintain our estimates. Overall, we expect revenues and earnings to grow at 9.3% and 14.2% CAGRs, respectively, over FY19-FY22e with 210bps Ebitda margin expansion including large product opportunities. Strong PAT growth would be driven by revenues from generic Suboxone, Nuvaring and Copaxone, which together would contribute ~15.6% to EPS in FY22e. Gross margin had been weak over the past two quarters with change in revenue mix.
Valuations and risks
We maintain Reduce rating on the stock with a revised target price of Rs 2,338/share (earlier: Rs 2,328). The key upside risks are: early launch of Nuvaring and/or Copaxone and early resolution of warning letter at the company’s Srikakulam facility.