Dr. Reddy's Laboratories' Q4FY19 results (Neutral) - Soft quarter

Q4FY19 result highlights

• Consolidated revenues (adj for Rs1.8bn derma brands divestment proceeds) came at Rs 38.4bn vs est of Rs 39.bn (Q3 was Rs 38.5bn). US revs came lower at $212m (Q3 $205m; est $223m). The domestic business grew at 6% yoy vs est of 10% (-4% qoq) and was marginally offset by PSAI sales of Rs 6.8bn (est of Rs 6.4bn).
• Adj. EBITDA came lower at ~Rs6.4bn/16.7% (Rs8.2bn in Q3) vs est of Rs8.1bn/18.8% margins. Big negative surprise was the lower GPs which came at 50.2% due to lower PSAI GMs (21% vs est of 26%) and weak Global generics GMs at 56% (est 60%). Mgt ascribed lower GMs to an unspecified mix of recurring and non-recurring factors and guided to some pickup in the same. SG&A came at Rs9.2bn (+2% yoy; est of Rs9.3bn) while R&D stood lower at Rs 3.6bn (-16 yoy / flat qoq) 
• Tax rate stood lower at 25.8% (est 29%). Adj, PAT came in lower at Rs2.38bn (est Rs3.74bn) due to lower-than-expected sales across all segments barring PSAI.
• Update on Big 4 products :1) gCopaxone – Launch unlikely in FY20 due to receipt of FDA queries 2) gNuvaring – CRL responded and granted priority review - expected launch in 1HFY20 3)gSuboxone –Relaunched 4) DFN-02: Expected launch in H1FY20.
• Srikakulam API plant – Resolution subject to re-inspection.

Key positives: Higher PSAI sales, lower tax rate

Key negatives: Lower US revenues, India sales

Impact on financials: Lower FY20 and FY21 earnings by 6% / 2%

Valuations & view

DRL’s Q4 results have been a disappointment.  At a broader level, 37% EBITDA growth in FY19 despite 8% yoy decline in US generic sales underlines the significant operational turnaround effected by DRL’s new management team over the last few quarters. Strong growth in EM sales combined with focus on broad-based cost rationalization have enabled strong earnings recovery despite limited / negative contribution from the US business over this period. We believe this dual growth engine has created a strong platform for medium term growth with the anticipated pick-up in US sales significantly adding to the momentum. DRL continues to have one of the most valuable ANDA pipeline amongst peers which should deliver going forward. Recent launches of interesting products like gCubicin, gPropofol highlight the potential of the pipeline. Operationally, we believe that DRL has turned the corner and the worst is likely behind. Delay in big ticket launches (as reflected in multiple delays in gCopaxone guidance) does remain a risk to estimates. Maintain Neutral with target price of 2782 (18x FY21E).​