Dr Reddy’s Q1: Even beyondone-offs, underlying results weak

Needs consistent performance in the next two-three quarters, beyond gRevlimid opportunity, to justify its current valuation of 20 times one year forward estimated earnings.

Dr Reddy’s got off to a muted start in Q1 FY23 missing revenue and EBITDA consensus by 3 and 15 per cent. In probably a reaction to this, the stock declined 4 per cent on Friday. Tough competition in the US, forex impact and higher commodity costs hit operations. Dr Reddy’s reported ₹5,233-crore revenue, which is a 6 per cent YoY growth and 4 per cent QoQ decline. The EBITDA margin of 18 per cent declined by 200 basis points QoQ and was flat YoY.

But the quarter and the comparable base quarters have several one-offs complicating like-to-like comparison. The current quarter revenues include ₹230 crore of proceeds from brand sales in India, while Q1FY22 revenues included a healthy contribution from Covid sales in India. The emerging market sales had a large contribution from Russian stocking last quarter (Q4FY22) which has impacted current quarter demand. Adjusted for these, the company may have reported a low double-digit growth in India (closer to expectations).   The company’s performance in North America has also been lacklustre. Dr Reddy’s faced tough competition in several of its limited competition products in the US, which led to constant currency sales of $230 million in Q1FY23, compared to average run rate of $250 million in the last four quarters.

On the margin front, lower realisations from the US, higher raw material costs and forex impact (forex alone may have contributed 150 bps impact on gross margins) dragged margins lower. Adjusted for all one-offs the company may have reported EBITDA margin closer to the bottom end of 21-25 per cent, which is disappointing compared to its aspirational 25 per cent EBITDA margin range.

Outlook and valuation

Looking forward, the big opportunity has to be generic lenalidomide (Revlimid) to be launched by September. The volume limited launch, without significant price competition, should add 5-10 per cent to US revenues in the first year itself. The 25-product launch plan reiterated by Dr Reddy’s, including complex products and injectables (one product approved by US FDA from its new plant) should sustain a mid to high single digit growth in North America. Indian operations should brace for a 5 per cent sales decline going forward assuming a three times price to sales for the disposed brands (₹230 crore received). This must be made up by strong launch trajectory and pricing growth domestically. The margins should improve post the sale, assuming disposal of non-core brands.

Dr Reddy’s needs consistent performance in the next two-three quarters, beyond gRevlimid opportunity, to justify its current valuation of 20 times one year forward estimated earnings. This is still a significant discount to industry leaders Sun Pharma and Cipla which are trading at 25-27 times owing to better revenue growth visibility. Year to date, Dr Reddy’s stock price has corrected by 15 per cent and one year forward valuations have shrunk 25 per cent.