Strong US pipeline, sustained growth trajectory main trigger for Dr Reddy's

Excluding the strong US show led by Revlimid, Q2 was a mixed bag

Pharma major Dr Reddy’s Laboratories (DRL) posted better-than-expected September quarter results, riding on sales of the generic version of cancer drug, Revlimid in the US market. The launch of the limited competition product, production-linked incentives and product mix resulted in the company exceeding street estimates for operating and net profit by 40-50 per cent.

Tushar Manudhane and Sumit Gupta of Motilal Oswal Research had factored in sales of $30 million for Revlimid given that it was launched in September. With the North American sales at $344 million (44 per cent of overall sales) in the quarter as compared to $230 million in June quarter, sales for Revlimid is estimated to be in the $110-$115 million range.

The company expects the drug to contribute meaningfully in the coming quarters though further gains are not easy to ascertain. Say Saion Mukherjee and Aneesh Deora of Nomura Research, “DRL has a track record of launching limited competition products that could potentially present upside to our estimates. However, we expect US upsides to have limited impact on the company’s valuation as these are typically unsustainable and difficult to forecast.”

The company launched seven products in the quarter and the launch momentum is expected to remain strong in the second half of the financial year. Excluding Revlimid, the company expects the US market to deliver single-digit growth on a sustainable basis. DRL has a strong US drug pipeline which including 81 pending filing including first-to-file opportunities and is focussing on biosimilars.

If sales of Revlimid are excluded, revenue performance in the quarter came in marginally lower than estimates. This is due to muted performance of the domestic and pharma service and ingredient (PSAI) business. Given the high Covid base of last year, India sales (18 per cent of revenues) grew just 1 per cent while adjusting for the same, growth is estimated to be in double digits. The company is focussing on growing the domestic business through the inorganic route, partnerships in key therapies while divesting non-core brands. The PSAI business (10 per cent of sales) disappointed falling by 23 per cent y-o-y on account of a high Covid base last year; lower offtake of a few products had impacted the business in Q1.

Barring Russia, most countries in the emerging markets area (20 per cent of sales), registered a dip in sales. While Russia saw a growth of 5 per cent, CIS and Romania registered a decline of a per cent. Rest of the world sales too fell by 18 per cent.

On the profitability front, while gross margins stood at just under 58 per cent, the company indicated that on a sustainable basis margins would be in the 51-54 per cent range. Operating profit margins excluding one-offs in the quarter is estimated at 20.7 per cent. While margins adjusted for Revlimid improved sequentially, it is still below historic levels, say analysts at Prabhudas Lilladher Research.

Motilal Oswal Research has maintained its earnings per share estimates for FY23 and FY24 to factor the incremental sales of Revlimid, moderation in sales/profitability of PSAI, Europe and CIS business and ongoing price erosion in the US generics base business.

The street will focus on the execution of various initiatives in non-US markets and the pace of growth. Clarity around multiple initiatives and successful execution are expected to drive the valuation multiple higher in due course, believes Nomura Research. The stock which declined marginally on Monday is trading at 15 times its FY24 earnings estimates. While most brokerages have a buy, investors should await the growth trajectory in the US/India market before considering the stock.