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MOSL: DR REDDY’S LABS (Neutral)-Ex-US trends favorable, cost-cut benefits visible

DR REDDY’S LABS: Ex-US trends favorable, cost-cut benefits visible

(DRRD IN, Mkt Cap USD6.5b, CMP INR2755, TP INR2590, 6% Downside, Neutral)

• PSAI/EM/EU drive growth: Adjusting for one-time income of INR7.2b as license fee for two brands, sales increased 7.5% YoY to INR40.8b (our estimate: INR41.9b) in 2QFY20, led by PSAI (+18% YoY), EMs (+10% YoY) and Europe (+44% YoY), partly offset by muted growth in the US (flat YoY). For 1HFY20, sales/EBITDA increased 5% YoY to INR79b/INR15.7b, while PAT was down 12% YoY to INR8.5b.
• Cost measures offset adverse mix impact, drive margins: Adjusting for the sale of brands and voluntary recall of Ranitidine from the US market, the gross margin shrank ~350bp YoY to 51.5%, mainly due to price erosion in the US base business and higher cost of revenue in PSAI. However, controlled SG&A expense (-290bp YoY), adjusting for impairment and one-offs, and lower R&D spend (-180bp YoY) drove 130bp YoY expansion in the EBITDA margin to 20.8% (our estimate: 20.0%). EBITDA thus came in line with our estimate at INR8.5b. Further, DRRD recognized deferred tax asset (INR5.2b) related to MAT credit. Adj. PAT declined 20% YoY to INR4b (in-line).
• Key concall takeaways: (1) DRRD received complete response letter (CRL) from the USFDA on g-Nuvaring and g-Copaxone. It would file response for the same over the next few months. (2) Company expects USFDA inspection at CTO-6 in near future. (3) Adverse impact of nationwide recall of Ranitidine from the US is fully factored in 2Q. (4) While 2Q US sales were impacted by product recall and logistics issues, DRRD guided for normalization 3Q onward. (5) R&D spend guided at USD200-240m for FY20.