Dr. Reddy's Laboratories' Q2FY19 results (Underperformer) - Broadly inline; PAT aided by other income

Q2FY19 result highlights

• Revenues came higher at Rs38b, vs est of Rs36.6b led by higher than expected sales in domestic market, branded formulation exports as well as PSAI. The negative surprise was on lower US revs at $207m (Q1 $237m; est $212m) indicating continued pricing pressure on the base business given the increasing competition in some high value assets.
• EBITDA came higher at ~Rs7.4bn/19.5% (Rs7.6bn in Q1) vs est of Rs7.1bn/19.4% margins. GPs (partially aided by forex movement) were in line at 55% aided by higher PSAI GMs (28.1% vs est of 22%) even though Global generics GMs were low at 59.3% (est 61%). SG&A came at Rs9.4bn (+16% yoy; est of Rs8.8bn) while R&D flat yoy / qoq 
• Tax rate stood significantly lower at 12.8% (est 21%). PAT came in higher at Rs5.04bn (est Rs3.42bn) aided by higher other income at Rs625mn (incl Rs454mn on sale of Cloderm brand and Bristol manufacturing facility. Further, we estimate forex gains of ~Rs500mn.
• Update on Big 4 products :1) gCopaxone – DMF CRL/ANDA filing responded; 2HCY19 launch guidance maintained 2) gNuvaring – CRL responded and granted priority review - expected launch in 1HCY19 3)gSuboxone –Court decision expected before 4^th January’2019 4) DFN-02: PDUFA date in Q4FY19; expected launch in Q1FY20
• Plant resolution: Srikakulam API plant –USFDA has issued additional queries. Duvvada – USFDA inspection is going on currently.

Key positives: Higher India / branded formulations / API sales; higher PSAI margins, lower tax rate and higher other income

Key negatives: Lower US revenues,

Impact on financials: We have increased FY19/20E earnings est by 8%/10% to build in higher EM sales, lower R&D costs and lower tax rates

Valuations & view

Despite the strong pick-up in EM / PSAI sales, DRL’s adjusted EPS run-rate continues to hover around ~Rs22-23/qtr. Given that current US sales base will continue to 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. This creates significant uncertainty in terms of predicting the timing and extent of DRL’s earnings recovery. Given the earning uncertainty, we maintain Underperformer with TP of Rs,2264 (18x FY20e). Further clarity on gSuboxone litigation outcome along with approval status for other key drugs will be triggers for upgrade.