Dr. Reddy's Laboratories' Q1FY19 results (Underperformer) - Earnings recovery gets further delayed

Q1FY19 result highlights

• Revenues came marginally lower at Rs37.2b, vs est of Rs37.6b led by lower US revs at $237m (Q4 $225m; est $250m) despite ~$20m gSuboxone supplies during the quarter. Domestic sales grew +30% to Rs6.1bn inline vs est. Branded formulations exports at Rs6.6bn vs est of Rs6.2bn due to strong Russia sales at Rs3.8bn (+9% yoy).
• EBITDA came in higher at ~Rs7.6bn / 20.4% (Rs5.5bn in Q4) vs est of Rs7.4bn/19.5% margins. While GPs were in line at 55.7%, SG&A and R&D costs came below estimates which aided EBITDA.
• Tax rate stood significantly lower at 8.9% vs est of 20%. Consequently PAT came in higher at Rs4.6bn (Rs3mn in Q4FY18) vs est Rs3.72bn
• Further delays in the Big 3 monetization :1) gCopaxone – DMF CRL expected to be responded shortly with 2HCY19 expected launch 2) gNuvaring – To respond to latest CRL in 2 months with expected launch in 1HCY19 3)gSuboxone – Clarity post court decision on appeal against the TRO – expected in Sept’18 (delays are possible)
• Plant resolution – Srikakulam API plant – DRL to submit data in Sept’18 post which FDA will determine next course of action. Duvvada – DRL has invited for re-inspection and awaits FDA’s visit.

Key positives: Steady gross margins and SG&A cost, lower tax rate 

Key negatives: Lower US revenues, higher working capital, delays in gNuvaring / gCopaxone launches and Srikakulam plant clearance.

Impact on financials: Maintain earnings estimates

Valuations & view

Adjusted for non-recurring items like gSuboxone contribution and lower taxes during the quarter, DRL’s adjusted EPS run-rate continues to hover around ~Rs20/qtr. Given that current US sales base will moderate with likely erosion in gToprol, gDacgoen etc. along with increase in R&D spends, launch of the Big 3 ANDAs remains vital to achieve the projected spike in EBITDA / earnings. Though DRL has one of the most valuable ANDA amongst peers, the timing of approval of big ticket drugs from this pipeline continues to remains unclear. The twists and turns in gSuboxone launch and multiple delays in gNuvaring / gCopaxone approval guidance underlines the challenges. This creates significant uncertainty in terms of predicting the timing and extent of DRL’s earnings recovery. Given earning uncertainty, we maintain Underperformer with TP of Rs2063 (18x FY20e). Further clarity on gSuboxone litigation outcome along with approval status for other key drugs will be triggers for upgrade.