Dr Reddys Laboratories Ltd Q2 FY2023 Concall Summary

Key Takeaways

• Record quarter, powered by launches and incentives: Sales, EBITDA and ROCE hit all-time highs, with gross margin surging 920 bps QoQ to 59.1% on new product mix and PLI benefit recognition, partly offset by a Rs.100 crores covid inventory provision.
• Lenalidomide launch delivers a meaningful US step-up: North America Generics grew 53% QoQ to \$351 million, driven by new launches including the volume-limited Lenalidomide; management expects the contribution to remain meaningful in coming quarters.
• Base business is steady, not spectacular: Excluding covid product sales and brand divestment income, India grew mid-teens YoY, while US base price erosion stayed within the normal trend; management describes US growth as single-digit on a multi-year basis with occasional blips.
• The 30% EBITDA margin is called "core," but the official aspiration stays at 25%: Management reiterated the sustainable margin target, framing the quarter's outperformance as an upside from launches and grant recognition that will fluctuate.
• What to watch next quarter: Whether Lenalidomide volumes sustain at a meaningful level, the pace of PSAI gross margin recovery after the covid provision, and any progress on the actively sought M&A deals management says the environment now favors.

Lenalidomide & the US Generics Surge

• The quarter's headline driver: North America sales jumped 53% QoQ to \$351 million, propelled by new product launches including the volume-limited launch of Lenalidomide capsules. Seven products were launched in the quarter.
• Volume is constrained by settlement: Quantities sold are within the scope of the agreement with the innovator, with specific volume-restriction dates in September, October, November, December and March. Management declined to share any further settlement details.
• Contribution expected to persist: Management plans to continue selling the product in a meaningful manner in the coming quarters, though it will not quantify the expected value. Additional competitors are likely to secure approval before January 2026.
• Base business price erosion: Remained within the normal trend seen over the last three quarters, consistent with management's multi-year view of single-digit US growth with occasional blips.
• Launch pipeline still loaded: The company expects launch momentum to continue through the balance of FY23 and into FY24, with plans to launch 25 products in the US this year.

Israeli: "We are planning to continue to sell this product in a meaningful manner also in the next coming quarters."

Margin Walk: Incentives, Mix & Provisions

• Gross margin leaped to 59.1%: The 920 bps QoQ expansion was driven by favorable product mix including new launches, plus recognition of PLI and export incentives worth Rs.193 crores. These were partially offset by a Rs.100 crores covid product inventory provision and some cost inflation.
• The PLI benefit is recurring, not a one-off: The Rs.193 crores recognized pertains to sales made in the first half of the fiscal year under a multi-year scheme. The quantum will fluctuate quarter-to-quarter based on qualifying product sales.
• The covid provision hit PSAI hardest: Without the Rs.100 crores provision taken across all geographies, PSAI gross margin would have been in the high single digits instead of the reported 3.6%. Management stated that without covid, the API business gross margin will absolutely grow.
• SG&A stayed disciplined: Increased 4% YoY and 7% QoQ in absolute terms, but as a percentage of sales fell 140 bps YoY and 340 bps QoQ, in line with business growth.
• Tax rate spike is jurisdictional mix: The higher tax rate this quarter was driven entirely by where sales are booked, including some impact of new product launches like Lenalidomide where IP resides. The normal ETR is expected to be 25-26%.
• Cost inflation easing at the margin: Management is seeing some softening in solvent costs, which should have a favorable impact in the second half, though costs remain elevated overall.

Agarwal: "I would say that our EBITDA margin of 30% is core. Having said that, I must clarify that what we have been stating very consistently is that our aspiration is to deliver 25% EBITDA margin on a sustainable basis in the near to medium term, and we remain on track for that target."

PSAI: The Drag That Should Fade

• Sales declined 29% YoY: Adjusted for covid product sales in the base quarter, the decline was in single digits, driven by lower volume pickup by customers for some key products. Sequentially, sales fell 12%.
• Gross margin collapsed to 3.6%: The twin hits were the covid inventory provision and adverse leverage on manufacturing overheads on a lower sales base. Without the provision, gross margin would have been high single digit.
• Recovery expected in coming quarters: Management expects sales improvement from increased volume pickup and new product launches, and gross margin is expected to improve.

India: Reshaping for a Top-5 Ambition

• Reported growth was muted: Sales grew 1% YoY and declined 14% QoQ. Adjusted for covid product sales in the base quarter and brand divestment income in Q1, the business grew mid-teens YoY and mid-single digit QoQ. Two new products were launched.
• Portfolio is being actively reshaped: The company is divesting non-core brands while focusing on growing big brands and pursuing acquisitions or partnerships in focus therapy areas.
• OTC and nutraceuticals are a strategic bet: Management is building a portfolio backed by scientific data, leveraging Dr. Reddy's brands and HCP relationships. The business model is expected to be stickier than Rx generics with higher profitability once brands are established.
• MR productivity push: Expected to increase significantly by focusing field force effort on more meaningful, data-backed products while divesting lower-productivity brands.
• Digital channels scaling: The company is expanding to more cities with partners and working on value channels including insurance, corporates, employees and direct; currently in a scaling phase.

Israeli: "I'm very confident that we are going to see very solid and we are reiterating that are going to be among top five player in India, and we are planning to achieve..."

Emerging Markets & Europe: Steady, With Russia Rebounding

• Emerging markets declined 6% YoY due to a higher base from covid product sales in Q2 FY22; adjusted for this, the business grew. Russia sales declined 2% YoY but grew 84% QoQ in constant currency after channel inventory stocking normalized in the prior quarter. Thirty-one new products were launched.
• Europe grew 10% YoY and 4% QoQ to €52 million, with 10 new products launched. Growth momentum is expected to continue through the rest of FY23.

Pipeline, R&D Strategy & Capacity Build

• ANDA filing count is deliberately lower: Only around 4 filings in H1 FY23, a combination of H2-weighted submission timing and a strategic shift toward differentiated products, biosimilars, and products with bigger potential rather than 30-40 filings per year. The target is around 20-25 products annually.
• Value-per-filing bet: Management expects R&D value derivation to be higher in the future because products are global, more complex, more injectable, and more biologics.
• Biosimilar milestones progressing: Partner Fresenius Kabi received US FDA approval for Pegfilgrastim, with Dr. Reddy's entitled to meaningful royalties from launch. Rituxan biosimilar remains on track to file in the US in 2023, with Dr. Reddy's manufacturing and Fresenius marketing.
• Injectables capacity expanding: The company recently qualified significant capacity and now has three relatively big facilities. It prefers to manufacture in-house as much as possible and describes its supply chain as risk-averse with no single product, activity, supplier or country dependency.
• CAPEX of ~Rs.1,500 crores for the full year is largely directed toward building capacity for biosimilar and injectable businesses, plus maintenance, digitalization and R&D facilities.
• Lexiscan generic settlement reached: A settlement has been signed; launch will occur in the future per confidential terms.

Capital Allocation: M&A Appetite Is Open

• Cash flow priorities are explicit: (1) CAPEX, future technologies and working capital; (2) business development; (3) if excess remains, consider distribution to shareholders, though no decision has been made on buybacks or dividends.
• M&A pipeline is active: Management is actively looking for deals across all geographies in both Horizon 1 and Horizon 2, and sees the geopolitical and economic situation creating opportunities at valuations that may have been higher in the past.
• Recent deal spend: Cash flow spending on intangibles of ~Rs.600 crores includes the Cidmus acquisition from Novartis, the Eton portfolio under development, and a small acquisition from Slayback.

Israeli: "We are actively looking for deals across all of the geographies which fits our strategy, both on Horizon 1 as well as Horizon 2. We feel also that the geopolitical situation as well as the economy situation create an opportunity for us. In that place, we do see opportunities that maybe in the past were in higher valuations."

Guidance & Commitments

Key Metrics