3QFY2017 Result Update | Pharmaceutical

February 22, 2017

Dr. Reddy’s Laboratories

NEUTRAL

CMP

`2,899

Performance Highlights

Target Price

Y/E March (` cr)

3QFY2017 2QFY2017

% chg (qoq) 3QFY2016

% chg (yoy)

Investment Period

Net sales

3,707

3,586

3.4

3,968

(6.6)

Gross profit

2,475

2,294

7.9

2,606

(5.0)

Stock Info

Operating profit

845

596

41.9

992

(14.9)

Sector

Pharmaceutical

Adj. net profit

470

295

59.4

579

(18.8)

Source: Company, Angel Research

Market Cap (` cr)

48,047

Net Debt (` cr)

(663)

Dr. Reddy’s Laboratories (DRL) posted lower than expected results for 3QFY2017.

Beta

0.5

In INR terms, the consolidated revenues came in at `3,707cr (v/s. `4,000cr

52 Week High / Low

3,689/2,804

expected) v/s. `3,989cr in 3QFY2016, down 6.6% yoy, mainly driven by pressure

Avg. Daily Volume

32,443

on the generic market. The global generic market with sales at `3,064cr (down

Face Value (`)

9.0% yoy), was mainly lead by Europe (`214.8cr, up 11% yoy) and Emerging

BSE Sensex

28,762

market (`594.8cr, a yoy dip of 7%). The PSAI segment posted sales of `540cr, up

Nifty

8,908

6.0% yoy. On the operating front, the EBIT margin came in at 9.7% (v/s. 17.1%

Reuters Code

REDY.BO

expected) v/s. 18.8% in 3QFY2016. Consequently, the PAT came in at `470cr

(v/s. `536cr expected) v/s. `579cr in 3QFY2016, a yoy de-growth of 18.8%. We

Bloomberg Code

DRRD@IN

maintain our Neutral rating.

A subdued quarter: Dr. Reddy’s Laboratories (DRL) posted results lower than

Shareholding Pattern (%)

expected. In INR terms, the consolidated revenues came in at `3,707cr (v/s.

Promoters

26.8

`4,000cr expected) v/s. `3,989cr in 3QFY2016, down 6.6% yoy, mainly driven by

MF / Banks / Indian Fls

10.7

pressure on the generic market. The global generic market with sales at `3,064cr

FII / NRIs / OCBs

54.0

(down 9.0% yoy), was mainly lead by Europe (`214.8cr, up 11% yoy) and

Indian Public / Others

8.5

Emerging market (`594.8cr, a yoy dip of 7%). The PSAI segment posted sales of

`540cr, up 6.0%. On the operating front, the EBIT margin came in at 9.7% (v/s.

17.1% expected) v/s. 18.8% in 3QFY2016. Consequently, the PAT came in at

Abs. (%)

3m 1yr

3yr

`470cr (v/s. `536cr expected) v/s. `579cr in 3QFY2016, a yoy de-growth of

Sensex

10.8

21.3

38.9

18.8%.

Dr Reddy

(7.5)

(5.3)

6.2

Outlook and valuation: We expect net sales to grow at a CAGR of 3.4% to

`16,542cr and adjusted EPS to post flat growth to end the period at `130.9 in

3-year Daily Price Chart

FY2018E. We recommend a Neutral rating on the stock given the valuations.

4,500

Key financials (IFRS Consolidated)

4,000

Y/E March (` cr)

FY2015

FY2016

FY2017E

FY2018E

3,500

Net sales

14,819

15,471

14,444

16,542

3,000

% chg

12.1

4.4

-6.6

14.5

Net profit

2,218

2,001

1,342

2,233

2,500

% chg

3.1

(9.8)

(33.0)

66.4

2,000

Adj net profit

2,218

2,357

1,342

2,233

% chg

3.1

6.3

(43.1)

66.4

Adj. EPS (`)

130.2

138.2

78.6

130.9

Source: Company, Angel Research

EBITDA margin (%)

22.2

24.6

18.0

23.0

P/E (x)

22.3

21.0

36.9

22.1

RoE (%)

21.9

19.7

10.1

15.2

RoCE (%)

18.1

18.7

9.7

15.3

P/BV (x)

4.4

3.9

3.6

3.2

Sarabjit Kour Nangra

EV/Sales (x)

3.3

3.2

3.4

3.0

+91 2 39357600 Ext: 6806

EV/EBITDA (x)

14.9

12.8

18.9

12.9

[email protected]

Source: Company, Angel Research; Note: CMP as of February 21, 2017

Please refer to important disclosures at the end of this report

Dr. Reddy’s Laboratories | 3QFY2017 Result Update

Exhibit 1: 3QFY2017 performance (IFRS, consolidated)

Y/E March (` cr)

3QFY2017

2QFY2017

% chg (qoq) 3QFY2016

% chg (yoy)

9MFY2017

9MFY2016

% chg

Net sales

3,707

3,586

3.4

3,968

(6.6)

10,421

11,715

(11.0)

Other income/(loss)

269

Total income

3,730

3,650

2.2

3,980

(6.3)

10,690

11,772

(9.2)

Gross profit

2,475

2,294

7.9

2,606

(5.0)

7,565

7,821

(3.3)

Gross margin (%)

66.8

64.0

65.7

72.6

66.8

SG&A expenses

1,134

1,177

(3.7)

1,204

(5.8)

3,437

3,407

0.9

R&D expenses

496

521

(4.9)

410

21.0

2,413

1,276

89.2

EBDITA

845

596

41.9

992

(14.9)

1,716

3,138

(45.3)

EBDITA (%)

22.8

16.6

25.0

16.5

26.8

Depreciation

285

0.0

246.6

15.5

790.5

720.4

9.7

Interest

PBT

583

375

55.5

758

(23.0)

1,194

2,475

(51.8)

Tax

122

38.1

179

(31.7)

270

539

(49.8)

Net Profit

461

287

60.9

579

(20.4)

924

1,936

(52.3)

Share of profit/ (loss) in associates

(8.4)

8.8

Reported net profit before exceptional

470

295

59.2

579

(18.9)

924

1,945

(52.5)

Exceptional items (loss) /profit

Reported PAT

470

295

59.4

579

(18.8)

924

1,945

(52.5)

Adj. Net Profit

470

295

59.4

579

(18.8)

924

1,945

(52.5)

EPS (`)

27.7

17.4

34.1

54.4

114.6

Source: Company, Angel Research

Exhibit 2: Actual Vs Estimates

(` cr)

Actual

Estimates

Variation (%)

Net sales

3,707

4,000

(7.3)

Other income

15.5

Operating profit

845

970

(12.9)

Tax

122

169

(27.8)

Adj. Net profit

470

536

(12.3)

Source: Company, Angel Research

Revenue lower than expectation: In INR terms, the consolidated revenues came in

at `3,707cr (v/s. `4,000cr expected) v/s. `3,968cr in 3QFY2016, down 6.6% yoy,

mainly driven by pressure on the generic market.

The global generic market with sales at`3,064cr (down by 9.0% yoy), was mainly

lead by the Europe (`214.8cr, up 11% yoy) and Emerging markets (`594.8cr, a

yoy dip of 7%). Other key markets like US dipped by 15% yoy to `1659.5cr,

whereas, India grew by 2% yoy to `594.7cr.

Revenues from North America declined 15% yoy, primarily on account of increased

competition in valgancyclovir and injectable franchise coupled with continuing

pricing pressure.

The PSAI segment posted sales of `540cr, up 6.0% yoy. The growth came in on the

back of US (`125.9cr, a yoy growth of 21%), Europe (`182.8cr, a yoy dip of 6.0%),

India (`40.9cr, a yoy dip of 34%) and ROW (`190.4cr, a yoy growth of 29%). As of

December 31, 2016, 92 generic filings are pending approval with the USFDA,

including 59 Para IVs (of which 20 are FTFs). Of these 90 ANDAs, 59 are Para IVs

out of which we believe 20 have ‘First to File’ status. Further, these 90 ANDAs

include 7 ANDAs, acquired from Teva, of which 6 are Para IVs.

February 22, 2017

Dr. Reddy’s Laboratories | 3QFY2017 Result Update

Exhibit 3: Trend in Global generics

4000

3500

3000

401

480

2500

123

581

428

123

527

595

194

625

2000

176

522

177

215

162

1500

1000

1,942

1,895

1,552

1,613

1,659

500

3QFY2016

4QFY2016

1QFY2017

2QFY2017

3QFY2017

Others

Russia & CIS

India

Europe

North America

Source: Company, Angel Research

In the PSAI segment (15% of sales), the US grew by 11% yoy; while ROW, Europe,

and India de-grew by 4%, 13% and 29% yoy respectively during the quarter.

Proprietary Products & Others (`102.7cr) posted a yoy de-growth of 5%.

Exhibit 4: PSAI trend

700

600

500

184

198

147

190

400

173

300

210

183

200

195

259

195

100

104

114

126

3QFY2016

4QFY2016

1QFY2017

2QFY2017

3QFY2017

Others

India

Europe

North America

Source: Company, Angel Research

February 22, 2017

Dr. Reddy’s Laboratories | 3QFY2017 Result Update

EBITDA margin dips yoy: On the operating front, lower sales led the EBIT to come

in at 9.7% (v/s. 17.1% expected) v/s. 18.8% in 3QFY2016. The EBITDA margin

came in at 16.6% (v/s. 17.2% expected) v/s. 25.8% in 3QFY2016, which was hurt

on account of lower sales and 5.8% yoy growth in SG&A expenses. R&D

expenditure for the quarter amounted to

13.4% of sales (v/s.

10.3% in

3QFY2016).

Exhibit 5: EBITDA margin trend (%)

28.0

25.8

23.0

24.0

22.0

20.0

16.6

14.7

16.0

12.0

8.0

4.0

0.0

3QFY2016

4QFY2016

1QFY2017

2QFY2017

3QFY2017

Source: Company, Angel Research

Net profit lower than expected: Other income for the quarter came in at ~`23cr

(v/s. `12cr in 3QFY2016). The net profit stood at `470cr (v/s. `536cr expected)

v/s. `579cr in 3QFY2016), a yoy de-growth of 18.8%.

Exhibit 6: Adjusted net profit trend

700

579

600

470

500

376

400

295

300

200

126

100

3QFY2016

4QFY2016

1QFY2017

2QFY2017

3QFY2017

Source: Company, Angel Research

February 22, 2017

Dr. Reddy’s Laboratories | 3QFY2017 Result Update

Concall takeaways

 Remediation process over; Inspection at all three facilities are expected in

Feb/ Mar’2017.

 DRL expects 15 ANDA launches in FY2018 (including

4-5 meaningful

launches.

 Plans to file 25 US ANDA’s in FY2017.

 Effective Tax rate to be 20-22% of PBT in FY2017.

 The company incurs 12-15% of its total R&D spends on bio-similar research.

Investment arguments

Robust growth in the US going ahead: After attaining a critical mass (US$1,139mn

in FY2016), DRL aims to scale up its business to the next orbit in the US market on

the back of a strong product pipeline (92 ANDAs are pending approval, of which,

59 are Para IVs and 20 are FTFs). The Management has guided for a robust

growth in the US over the medium term, driven by introduction of new products,

some of which are also Para IV opportunities. Owing to the import alert on the

three facilities of the company, in a worst case scenario, we expect the ex-

exclusivity US sales to post a flat growth during FY2016-18E.

Domestic back in focus: DRL reported a 19.0% yoy growth in FY2016. The

management expects the company’s performance to rebound and targets to

achieve an above industry growth rate going ahead, driven by a) field force

expansion and improvement in productivity, b) new product launches (including

biosimilars), and c) focus on brand building. In 4QFY2015, DRL had acquired

UCB’s India portfolio and has completed the integration process of these brands in

1QFY2016. UCB’s India business had registered ~`150cr sales in CY2014 and

has a branded portfolio of

21 products focusing on Allergy, Respiratory,

Dermatology and Pediatric space. The acquisition had been successfully integrated

by 2QFY2016. Thus, we expect sales in India to post a CAGR of ~7.8% over

FY2016-18E.

Valuation: We expect net sales to grow at a CAGR of 3.4% to `16,542cr and

adjusted EPS to post flat growth to end FY2018 at

`130.9 over

FY2016-18E. The stock has been severely beaten down post the import alert from

the USFDA. However, considering the valuations, we recommend a Neutral rating

on the stock.

Exhibit 7: Key assumptions

FY2017E

FY2018E

PSAI segment growth (%)

(4.2)

(0.5)

Generics segment growth (%)

(8.0)

17.0

Operating margin (%)

18.0

23.0

Capex (` cr)

1200

Source: Company, Angel Research

February 22, 2017

Dr. Reddy’s Laboratories | 3QFY2017 Result Update

Exhibit 8: PE chart

5,000

4,000

3,000

2,000

1,000

Price

20x

25x

30x

35x

Source: Company, Angel Research

Exhibit 9: Recommendation summary

Company

Reco.

CMP Tgt Price Upside

FY2018E

FY16-18E

FY2018E

(`)

(%)

EV/Sales

EV/EBITDA

CAGR in EPS

RoCE

RoE

(x)

(%)

Alembic Pharma

Neutral

593

19.5

2.6

12.2

(10.8)

27.5

25.3

Aurobindo Pharma Buy

686

877

27.9

14.5

2.4

10.1

18.1

22.5

26.1

Cadila Healthcare Neutral

440

22.9

3.6

16.6

13.5

23.6

27.1

Cipla

Sell

593

465

(21.5)

24.2

2.7

16.3

14.2

12.2

13.9

Dr Reddy's

Neutral

2,899

22.1

2.6

11.4

(2.7)

15.3

15.2

Dishman Pharma Neutral

229

20.3

2.3

10.0

13.3

10.3

10.9

GSK Pharma*

Neutral

2,683

44.5

6.8

32.8

16.9

37.5

34.5

Indoco Remedies

Reduce

272

240

(11.8)

17.0

2.0

10.9

33.2

19.1

20.1

Ipca labs

Accumulate

554

613

10.7

28.1

1.9

12.7

36.5

8.8

9.4

Lupin

Buy

1,469

1,809

23.1

21.2

4.0

13.1

17.2

24.4

20.9

Sanofi India

Neutral

4,186

24.3

3.2

17.4

22.2

25.6

28.8

Sun Pharma

Buy

673

847

25.8

19.1

4.0

12.2

26.5

18.9

20.1

Source: Company, Angel Research; Note: *December year ending

Company Background

Established in

1984, Dr. Reddy's Laboratories is an integrated global

pharmaceutical company, through its three businesses - Pharmaceutical Services

and Active Ingredients, Global Generics and Proprietary Products. The company’s

key therapeutic focus is on gastro-intestinal, cardiovascular, diabetology,

oncology, pain management, anti-infective and paediatrics. The company’s key

markets include India, USA, Russia & CIS and Germany.

February 22, 2017

Dr. Reddy’s Laboratories | 3QFY2017 Result Update

Profit & loss statement (IFRS Consolidated)

Y/E March

FY2013

FY2014

FY2015

FY2016

FY2017E FY2018E

Net sales

11,627

13,217

14,819

15,471

14,444

16,542

Other operating income

247.9

141.6

91.7

87.4

Total operating income

11,875

13,359

14,911

15,558

14,532

16,630

% chg

21.8

12.5

11.6

4.3

-6.6

14.4

Total expenditure

8,951

10,096

11,535

11,669

11,851

12,744

Cost of revenues

4,825

4,977

5,531

5,315 5,423.20

5,630.35

SG&A expenses

3,358

3,878

4,259

4,570

4,261

4,632

R&D expenses

767.3

1,240.2

1,744.9

1,783.4

2,166.7

2,481.4

EBITDA

2,676

3,121

3,284

3,802

2,593

3,799

% chg

3.0

16.6

5.2

15.8

(31.8)

46.5

(% of Net Sales)

23.0

23.6

22.2

24.6

18.0

23.0

Depreciation & amortisation

743.7

659.8

747.4

927.4

990.1

1,052.8

EBIT

1,932

2,462

2,537

2,875

1,603

2,746

% chg

4.3

27.4

3.1

13.3

(44.2)

71.3

(% of Net Sales)

16.6

18.6

17.1

18.6

11.1

16.6

Interest & other charges

Other Income

46.0

40.0

168.2

(270.8)

(% of PBT)

2.1

1.5

6.0

(10.0)

Share in profit of associates

10.4

17.4

19.5

22.9

Recurring PBT

2,237

2,661

2,816

2,714

1,714

2,856

% chg

14.7

19.0

5.9

-3.6

(36.9)

66.7

Extraordinary expense/(Inc.)

68.8

508.5

PBT (reported)

2,167.7

2,660.6

2,816.3

2,714.0

1,713.6

2,856.4

Tax

490.0

509.4

598.4

712.7

372.0

623.4

(% of PBT)

22.6

19.1

21.2

26.3

21.7

21.8

PAT (reported)

1,677.7

2,151.2

2,217.9

2,001.3

1,341.7

2,233.0

Add: Share of earnings of asso.

Less: Minority interest (MI)

Exceptional items

PAT after MI (reported)

1,677.7

2,151.2

2,217.9

2,001.3

1,341.7

2,233.0

ADJ. PAT

1,750.0

2,151.2

2,217.9

2,357.0

1,341.7

2,233.0

% chg

17.0

22.9

3.1

6.3

(43.1)

66.4

(% of Net Sales)

14.4

16.3

15.0

12.9

9.3

13.5

Basic EPS (`)

103.1

126.7

130.2

138.2

78.6

130.9

Fully Diluted EPS (`)

103.1

126.7

130.2

138.2

78.6

130.9

% chg

16.8

22.9

2.7

6.1

(43.1)

66.4

February 22, 2017

Dr. Reddy’s Laboratories | 3QFY2017 Result Update

Balance sheet (IFRS Consolidated)

Y/E March (` cr)

FY2013

FY2014

FY2015

FY2016

FY2017E FY2018E

SOURCES OF FUNDS

Equity share capital

84.9

85.2

85.3

Preference Capital

Reserves & surplus

7,224

8,995

11,045

12,748

13,691

15,525

Shareholders funds

7,309

9,080

11,130

12,834

13,776

15,610

Minority Interest

Total loans

3,676.0

4,474.2

3,954.3

3,661.9

Deferred tax liability

83.3

(192.9)

(401.3)

(423.0)

Total liabilities

11,068

13,361

14,683

16,073

17,015

18,849

APPLICATION OF FUNDS

Net fixed assets

3,781

3,945

4,314

5,396

6,596

7,796

Goodwill /other intangibles

1,402

1,470

1,643

1,969

Capital Work-in-Progress

495.2

Investments

1,764

2,589

3,811

3,833

Current Assets

6,875

7,866

8,558

8,465

7,997

9,205

Cash

513.6

845

539

492

200

282

Loans & Advances

697.6

793.0

889.1

928.2

866.7

992.5

Other

5,664

6,228

7,129

7,045

6,930

7,931

Current liabilities

3,252

3,006

4,214

4,193

3,982

4,557

Net Current Assets

3,623

4,860

4,344

4,273

4,015

4,649

Other Assets

106

Total Assets

11,068

13,361

14,683

16,073

17,015

18,849

February 22, 2017

Dr. Reddy’s Laboratories | 3QFY2017 Result Update

Cash flow statement (IFRS Consolidated)

Y/E March (` cr)

FY2013

FY2014

FY2015

FY2016

FY2017E FY2018E

Profit before tax

2,237

2,661

2,816

2,714

1,714

2,856

Depreciation

744

660

747

927

990

1,053

(Inc)/Dec in Working Capital

535

(906)

211

(35)

(552)

Less: Other income

168

(271)

Direct taxes paid

490

509

598

713

372

623

Cash Flow from Operations

2,980

1,865

3,008

3,224

2,297

2,734

(Inc.)/Dec.in Fixed Assets

(431)

(164)

(369)

(1,082)

(1,200)

(Inc.)/Dec. in Investments

687

824

1,222

Other income

168

(271)

Cash Flow from Investing

302

701

1,021

(1,331)

(1,200)

Issue of Equity

Inc./(Dec.) in loans

(1,155)

798

(520)

(292)

Dividend Paid (Incl. Tax)

298

358

399

Others

(2,649)

(3,390)

(4,214)

(2,047)

(1,789)

(1,851)

Cash Flow from Financing

(3,506)

(2,234)

(4,335)

(1,940)

(1,389)

(1,452)

Inc./(Dec.) in Cash

(224)

331

(306)

(47)

(292)

Opening Cash balances

738

514

845

539

492

200

Closing Cash balances

514

845

539

492

200

282

February 22, 2017

Dr. Reddy’s Laboratories | 3QFY2017 Result Update

Key ratios

Y/E March

FY2013

FY2014

FY2015

FY2016

FY2017E

FY2018E

Valuation Ratio (x)

P/E (on FDEPS)

28.1

22.9

22.3

21.0

36.9

22.1

P/CEPS

20.3

17.5

16.7

16.9

21.2

15.1

P/BV

6.7

5.4

4.4

3.9

3.6

3.2

Dividend yield (%)

0.5

EV/Sales

4.4

3.8

3.3

3.2

3.4

3.0

EV/EBITDA

18.9

16.1

14.9

12.8

18.9

12.9

EV / Total Assets

4.6

3.8

3.3

3.0

2.9

2.6

Per Share Data (`)

EPS (Basic)

103.1

126.7

130.2

138.2

78.6

130.9

EPS (fully diluted)

103.1

126.7

130.2

138.2

78.6

130.9

Cash EPS

142.6

165.5

174.0

171.7

136.7

192.6

DPS

15.0

Book Value

430.4

534.7

653.3

752.3

807.5

915.0

Dupont Analysis

EBIT margin

16.6

18.6

17.1

18.6

11.1

16.6

Tax retention ratio

77.4

80.9

78.8

73.7

78.3

78.2

Asset turnover (x)

1.2

1.1

1.0

0.9

ROIC (Post-tax)

14.9

17.4

15.1

14.3

7.8

12.2

Cost of Debt (Post Tax)

0.0

Leverage (x)

0.6

0.4

0.3

0.2

Operating ROE

23.5

24.7

20.4

18.3

9.7

15.1

Returns (%)

ROCE (Pre-tax)

17.8

20.2

18.1

18.7

9.7

15.3

Angel ROIC (Pre-tax)

23.1

25.6

22.5

22.9

11.7

18.0

ROE

26.8

26.3

21.9

19.7

10.1

15.2

Turnover ratios (x)

Asset Turnover (Gross Block)

3.3

3.5

3.6

3.2

2.4

2.3

Inventory / Sales (days)

Receivables (days)

Payables (days)

WC cycle (ex-cash) (days)

104

Solvency ratios (x)

Net debt to equity

0.4

0.3

0.2

0.3

0.2

Net debt to EBITDA

1.2

1.0

0.8

1.3

0.9

Interest Coverage (EBIT / Int.)

February 22, 2017

Dr. Reddy’s Laboratories | 3QFY2017 Result Update

Research Team Tel: 022 - 39357800

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Ratings (Based on expected returns

Buy (> 15%)

Accumulate (5% to 15%)

Neutral (-5 to 5%)

over 12 months investment period):

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February 22, 2017