Dr. Reddy's Laboratories' Q4FY18 results (Underperformer) - Weak quarter; uncertainty on key launches stays

Q4FY18 result highlights

• Revenues came lower at Rs35.3b, vs est of Rs38.3b led by lower US revs at $225m (Q3 $248m; est $250m). Domestic sales grew +16% (LTL growth) to Rs6.1bn vs est of Rs6.3bn. Branded formulations exports were Rs5.5bn vs est of Rs6.5bn due to weak Russia sales (attributed to change in trade stocking trends). PSAI revs were Rs6.2b vs Rs5.7b est.
• Rev miss generated significant negative operating leverage; EBITDA came in lower at ~Rs5.5bn / 15.6% (Rs7.7bn / 20.2% in Q3) vs est of Rs7bn/18.2% margins. GPs stood lower at Rs18.9bn vs est of Rs20.7bn with GMs at 53.5% vs est of 54%. SG&A cost stood higher at Rs9bn (+3% qoq adjusting). R&D costs stood lower at Rs4.4bn (-7% qoq).
• DRL booked ~Rs1bn interest income largely driven by gain on sale of investments. Tax rate stood lower at 22%. Consequently PAT came in lower at Rs3bn (Rs3.3mn in Q3FY18) vs est Rs3.86bn
• The key near term monitorable continues to be the big 3 products:1) gCopaxone – DMF CRL expected to be responded in couple of months with 1HFY20 expected launch 2) gNuvaring – DRL to submit response to FDA queries shortly and expects to launch in 2HFY19 3)gSuboxone – responded to the FDA queries and continue to monitor the litigation proceedings

Key positives: Steady gross margins and SG&A cost

Key negatives: Lower sales across geographies especially US sales

Impact on financials: We have reduced our FY19/20 est by 20%/21% to factor in delays in big ticket US launches

Valuations & view

Despite flattish R&D spends and SGA cost optimization, DRL’s adjusted EPS run-rate continues to hover around Rs15-20/qtr. Given that current US sales base will moderate with likely erosion in gToprol, gDoxil and other key drugs along with increase in R&D spends, launch of multiple big ticket ANDAs (amongst gCopaxone / gNuvaring / gSuboxone) 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 new big ticket drugs from this pipeline remains unclear for now, as highlighted by the mgt. This creates significant uncertainty in terms of predicting the timing and extent of recovery in DRL’s FY19 earnings. Given reasonably rich valuations and earnings uncertainty, we maintain Underperformer with TP of Rs2063 (18x FY20e). Further clarity on the niche ANDA approvals will be trigger for upgrade.