Dr Reddy's Laboratories - Imitrex shines, core business struggles

The performance of authorised generic Imitrex has so far been surprisingly good, and looks set to continue its good run into 4Q. In our view the market is likely to wait for stabilisation in Dr Reddy's major business divisions, in particular Domestic formulations, Betapharm and PSAI, before re-rating the stock.

3QFY09 results– authorised generic Imitrex boosts reported results
Dr Reddy’s reported net revenues of Rs18.4bn (+49% yoy), 6% higher than our estimate. The main surprise was higher than expected gImitrex sales at $72m vs our expectation of $40m. Excluding this, core business revenues were up 21% yoy to Rs14.9bn but 4% below our estimate. Higher margins associated with gImitrex sales boosted the EBIT margin to 21% (+1272bp yoy). Core PAT doubled to Rs1.9bn, translating into EPS of Rs11.4.

Core businesses yet to stabilise
Most of the major business divisions disappointed us. Domestic formulation and Betapharm registered 1% and 3% declines, respectively, while the PSAI (erstwhile API & Custom Pharma) business was flat, excluding the Dow Pharma acquisition. Management attributed the weak performance to a delay in new product launches and a change in supply chain model (in the case of Domestic formulation), destocking due to the AOK tender, and Olanzapine withdrawal from market (in the case of Betapharm). The company indicated that the Domestic formulation business may take a few more quarters to stabilise, while remaining non-committal on Betapharm’s outlook. Furthermore, none of the top 10 products (likely sales of $100m+) in Betapharm appears in the eight contracts awarded by AOK, which might necessitate impairment charges in future quarters. The company is also trying to focus more on its CMO (contract manufacturing) division than its CRO (contract research) division. Overall, we believe it will take two or three quarters for the various businesses to stabilise.

Near-term triggers appear limited
We maintain our estimates and long-term Buy recommendation. The stock trades at 12.1x our FY10F earnings and appears attractive, however we note that the market is likely to wait for Dr Reddy’s various businesses to stabilise before re-rating the stock.