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MOSL: DR REDDY’S LABS (Neutral)-Weak quarter-margin recovery is key

​Dr Reddy’s Labs: Weak quarter; margin recovery is key

(DRRDIN, Mkt Cap USD7.0b, CMP INR2622, TP INR2500, 5% Downside, Neutral)

• Weak operating performance: Net sales grew 2.5% YoY to ~INR33.2b (9% miss). Gross margin shrunk ~450bp YoY, primarily due to four factors: 1) double-digit price erosion in the US business (due to new competition and channel consolidation). 2) Impact of GST implementation. 3) Manufacturing overhead deleverage. 4) INR appreciation against USD. PAT declined >50% YoY to INR591m. Although some recovery in sales and EBITDA margin is expected in 2QFY18 led by channel refilling in domestic market and ramp-up of Doxil/Vytorin, pricing pressure in the US will continue exerting pressure.
• India business hurt by GST; recovery expected in 2Q: India business declined 10% YoY, primarily due to channel destocking ahead of GST roll-out. DRRD is witnessing traction in channel refilling in July-17. In FY18, DRRD expects its domestic business to grow in high-single-digit/low-double-digit.
• Pricing pressure in US continues: US sales for DRRD stood at USD230m in 1Q (-2.4% YoY, marginally up QoQ). DRRD witnessed double-digit price erosion in the US due to competition in key products and channel consolidation. Sales for gVidava/gValcyte declined ~USD11m QoQ. We expect pick-up in revenue 2Q onward, led by ramp-up of recent key launches – Vytorin and Doxil (combined opportunity will be >USD200m). This will be partially offset by the impact of new competition in Decitabine.