Pharmaceutical major Dr Reddy’s Laboratories delivered better-than-expected Q2 results, backed by strong contribution from the blockbuster cancer drug Revlimid and higher other income from benefits from the government's production-linked incentives.
However, brokerages see the drugmaker's high dependence on Revlimid, increased focus on inorganic growth and expensive valuations as major headwinds for Dr Reddy's.
Brokerage firm Noumra attributed Dr Reddy's better-than-expected Q2 results to higher non-recurring income due to a litigation settlement income of Rs 98.4 crore, higher grants from the PLI scheme (at Rs 160 crore against a quarterly average of Rs 75 crore) along with better US revenues, thanks to resilient Revlimid sales. Nomura has a 'neutral' call on the drugmaker with a target price of Rs 5,802.
Dr Reddy's reported its highest-ever net profit and revenue in Q2 at Rs 1,480 crore and Rs 6,880.20 crore. Not just that, both the net profit as well as revenue also topped the Street's expectations of Rs 1,290.7 crore and Rs 6,830.2 crore. EBITDA margin also expanded to 31.7 percent in July-September as against 30.6 percent in the base period.
However, much of the company's strong profitability in Q2 was on account of sales of high-margin Revlimid. "Excluding it, margins are subpar at 20 percent. We identify the reserves that Revlimid can generate to fund inorganic growth and R&D, but that also exposes it to margin and return risks post-Revlimid," Nuvama Institutional Equities mentioned in a note.
The drugmaker is also extensively exploring opportunities of inorganic growth to compensate for the loss of Revlimid contribution from FY26. But Nuvama believes that it might not be a smooth sail as Dr Reddy's core business remains under threat and runs the risk of returns tapering down.
On that account, Nuvama has a 'reduce' call on Dr Reddy's with a price target of Rs 4,670.
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Investec also believes that increased investments depressed Dr Reddy's near-term EPS, excluding Revlimid. On the other side, Investec also sees the company generating significant cash flow from Revlimid sales which helps it to evaluate better inorganic opportunities that could possibly lead to higher growth in the long run. The brokerage has a 'buy' call on Dr Reddy's with a target price of Rs 6,520.
Motilal Oswal Finacial Services also highlighted expectations of an earnings growth moderation for Dr Reddy's after a strong 31 percent earnings CAGR over FY21-23. "We expect earnings growth momentum to moderate to 12 percent CAGR over FY23-25 due to the high base on account of Revlimid and gradual recovery in Emerging Markets/Pharmaceutical services sales," MOFSL said in a note.
MOFSL also feels that the current stock valuation adequately factors any earnings upside for Dr Reddy's. Accordingly, the firm retained its 'neutral' call on the stock with a price target of Rs 5,400.
Dr Reddy's formulations unit in Hyderabad was slapped with a form 483 along with 10 observations by the US Food and Drug Administration over the weekend. The inspection was conducted from October 19-27.
At 9.41am, shares of Dr Reddy's were trading around 0.6 lower at Rs 5,365.60 on the NSE.
Also Read | Dr Reddy's Q2 results: Net profit jumps 33% YoY to Rs 1,480 cr, tops estimate
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