Edelweiss - Dr. Reddy's Laboratories - betapharm: still holding on; result update Q4FY07; maintain Accumulate

Dr. Reddy's Laboratories (DRRD IN, INR 666, maintain Accumulate)

Dr Reddy's (DRL) Q407 results were better than our expectations, with Y-o-Y sales growth of 125%, mainly on account of Ondansetron revenues. For the year, it reported a growth of 165% in revenues, 360% growth in EBITDA, and 472% growth in net profit.

DRL reported Ondansetron revenues of INR 2.9 bn. We believe these higher revenues could be on the back better-than-expected market share and some inventory build up during the quarter. Since Ondansetron have much higher margins (as it is sold under 180 days exclusivity) EBITDA margins at 35% were higher than expectations.

On the positive side, Betapharm has performed much better than expected in spite of significant pressure on pricing in the German market. The company recorded EBITDA of EUR 30 mn, translating into 21% margin for the whole year. DRL has managed to renegotiate manufacturing contracts and now it will be able to transfer manufacturing of 10 products to India by the end of FY08E. We believe this is likely to result in significant cost savings and could prevent margin erosion in the highly competitive German market. The company seems to have managed to improve volumes by new product introductions. With its new initiative of transferring manufacturing back to India, we believe Betapharm will perform much better than expected.

As expected, there was significant improvement in the base business with API revenues growing by 44% and CPS revenues growing by 133%, albeit on a lower base. API revenues were boosted by significant revenues from Sertraline and Rabeprozole. In US markets, DRL managed to gain ~62% market share in Ondansetron and it continues to hold on to its double digit market share in Fexofenadine, which contributed significantly to US generics revenues.

We are not changing our earnings estimates for FY08 or FY09. Everybody, including us, had concerns about the German market. But as the company has managed to address these concerns upfront, there is a possibility that Betapharm may surprise on the positive in Germany. We would like to wait and watch this space more closely till we get more clarity on future developments in the German market before we change our assumptions.

At CMP of INR 666, the stock trades at a P/E of 18.1x on our FY08E earnings with possible upside triggers from monetizing of Para IVs. Hence, we maintain our 'ACCUMULATE' recommendation on the stock.

Edelweiss - Dr. Reddy's Laboratories - betapharm: still holding on; result update Q4FY07; maintain Accumulate