Dr. Reddy’s results announced on Friday beat consensus estimates on revenue, EBITDA margin and earnings. The company’s Q2FY23 revenue of ₹6,332 crore (9 per cent YoY growth) was ahead of Bloomberg consensus estimates by 8 per cent. The adjusted EBITDA margin of 29 per cent was also 700 basis points ahead of estimates, leading to EPS beat of 24 per cent in the quarter, which came in at ₹64 per share.

US shines

Dr. Reddy’s reported sales of $351 million in Q2FY23 from the US, compared to $253 million in Q2FY22 or $230 million in Q1FY23. This growth is despite the base business continuing to face high erosion. The $100-120 million jump in revenues was aided by the launch of generic Revlimid (used in treatment of multiple myeloma), even as six other products were launched in the quarter. This launch performance was ahead of even consensus estimates driving the revenue and margin beat. The sales performance could have benefitted from channel stocking of generic Revlimid, which may decrease in the next few quarters. The competitive intensity from other generic launches will also increase going forward. But with volume limited launches till January-2026 for all players, the price erosion in generic Revlimid remains to be seen.

Other markets improve

The Russian market reported 4 per cent YoY growth as channel stocking of previous quarters has reduced and forex rates have improved. The drag from Russian operations on revenue and margin may improve going ahead, as the Russian markets and currency start normalising. India reported revenue growth of 1 per cent YoY in Q2FY23, on a high base, as the comparable quarter last year reported 25 per cent YoY growth. The management noted that excluding the Covid base effect, revenue growth would have been in the mid-teens in India. Similarly, the Rest of the World declining 18 per cent on account of a high Covid base in the previous year impacted the Emerging Markets segment, which declined by 6 per cent. At least in India, Covid sales in base performance should not be a significant comparable going ahead.

Better product mix aids margins

The management noted only a marginal improvement in raw material costs, but the margin improvement (440 basis points YoY in gross margins to 69 per cent) was primarily related to product mix improvement. This is after adjusting for a ₹193-crore gain from production-linked incentive flowing to the company, which may be a lumpy but regular feature in the short term. This improvement in gross margins flowed down to EBITDA margins as well.

Notably, the company maintained an R&D expense ratio at 7.7 per cent of sales in the quarter, with high revenue growth, leading to 10 per cent absolute growth YoY in developmental expense. The high revenue base from generic Revlimid will allow the company to pursue its longer-term goals in injectables, complex and biologics product development. The company retains its 25 product per year launch aspiration in the US, with a higher proportion of complex and injectable launches. The strong cash position improves the outlook that Dr. Reddy’s may pursue an inorganic growth option as well.

The lumpsum gains from the launch of generic Revlimid may ebb going forward, but the product development capabilities in India and the US as a result will materially improve the stock outlook. Our recent accumulate call on Dr. Reddy’s was considering the better prospects of the company. Based on Friday’s closing price, the stock is trading at around 22 times FY23 PE.