3QFY2013 Result Update | Pharmaceutical

February 21, 2013

Dr. Reddys Laboratories

Performance Highlights
Y/E March (` cr) Net sales Gross profit Operating profit Adj. net profit 3QFY2013 2,865 1,967 429 363 2QFY2013 2,881 1,531 553 494 % chg (qoq) (0.5) 28.5 (22.4) (26.4) 3QFY2012 2,769 1,658 739 513 % chg (yoy) 3.5 18.7 (41.9) (29.1)

NEUTRAL
CMP Target Price
Investment Period
Stock Info Sector Market Cap (` cr) Net Debt (` cr) Beta 52 Week High / Low Avg. Daily Volume Face Value (`) BSE Sensex Nifty Reuters Code Bloomberg Code Pharmaceutical 30,841 3,047 0.2 1,969/1,528 24,879 5 19,325 5,852 REDY.BO DRRD@IN

`1,878 -

Source: Company, Angel Research

Dr. Reddys Laboratories (DRL) reported more or less just-in 3QFY2013 top-line and bottom-line performance. The companys net sales increased by 3.5% yoy (23% adjusted for the base effect). The growth came in on back of 24% yoy (adjusted) in the US and Emerging Markets. On the EBIT margins came in at 15.0% V/s expected 15.8%. Consequently the net profit came in at `363cr, a dip of 29.1%, mostly in line with expectations of `339cr. We recommend a neutral on the stock. More or less results in line with expectations: DRL reported net sales of `2,865cr for 3QFY2013, registering 23.0% yoy growth, which was a tad lower than our estimate of `2,700cr. The U.S. and Emerging markets grew by 24% yoy (adjusted) were the key growth drivers for the company. The domestic market reported a strong growth of 12.0% yoy. On the positive side the PSAI segment posted a robust growth of 28.0% yoy during the quarter. The companys EBIT margin came in at 15.0% V/s expected 15.8% and contracting by 11.7%, leading to a dip of 29.1% to `363cr during the quarter. Outlook and valuation: DRL has reinforced its earlier revenue guidance of US$2.7bn by FY2013E with RoCE of 25%. We expect net sales to report a 9.8% CAGR to `11,662cr and adjusted EPS to record a 2.3% CAGR to `92.9 over FY2012-14E. We maintain our neutral on the stock.

Shareholding Pattern (%) Promoters MF / Banks / Indian Fls FII / NRIs / OCBs Indian Public / Others 25.6 22.0 44.3 8.1

Abs. (%) Sensex Dr Reddy

3m 4.7 4.6

1yr 4.9 10.5

3yr 19.4 61.8

Key financials (IFRS Consolidated)

Y/E March (` cr) Net sales % chg Net profit % chg Adj net profit % chg Adj. EPS (`) EBITDA margin (%) P/E (x) RoE (%) RoCE (%) P/BV (x) EV/Sales (x) EV/EBITDA (x)
Source: Company, Angel Research

FY2011 7,469 6.3 1,104 933.6 1,076 16.8 63.8 21.0 29.5 24.2 17.7 7.0 4.5 19.7

FY2012 9,674 29.5 1,426 29.2 1,507 40.0 88.8 24.1 21.1 29.1 20.9 5.6 3.8 14.3

FY2013E 10,696 10.6 1,420 (0.4) 1,420 (5.8) 83.7 20.7 22.4 22.4 15.0 4.7 3.4 15.1

FY2014E 11,662 9.0 1,576 11.0 1,576 11.0 92.9 21.0 20.2 20.8 15.1 3.9 3.0 13.1

Sarabjit Kour Nangra

+91 2 39357600 Ext: 6806 [email protected]

Please refer to important disclosures at the end of this report

Dr. Reddys Laboratories | 3QFY2013 Result Update

Exhibit 1: 3QFY2013 performance (IFRS, consolidated)

Y/E March (` cr) Net sales Other income Total income Gross profit Gross margin (%) Other expenses R&D expenses EBIT EBIT (%) Interest PBT Tax Net Profit Share of profit/ (loss) in associates Reported net profit before excep. Exceptional items Reported PAT Adj. Net Profit EPS (`)
Source: Company, Angel Research

3QFY2013 2,865 26 2,892 1,967 68.7 1,335 203 429 15.0 10 446 83 363 363 363 363 21.4

2QFY2013 2,881 40 2,921 1,531 53.1 801 176 553 19.2 (37) 630 139 491 2.8 494 86 407 494 29.1

% chg (qoq) (0.5) (33) (1.0) 28.5 29.2 66.6 15.2 (22.4) (29.2) (40.6) (26.0) (26.4) (10.8) (26.4)

3QFY2012 2,769 17 2,786 2,019 72.9 1,129 151 739 26.7 (17) 772 262 510 2.6 513 513 513 30.2

% chg (yoy) 3.5 3.8 (2.6) (5.8) 18.2 34.2 (41.9)

9MFY2013 8,287 93 8,379 5,724 69.1 3,837 535 1,352 16.3 (6)

9MFY2012 7,015 61 7,076 4,981 71.0 3,213 417 1,351 19.3 (7.8) 1,420 337 1,084 1,084 1,084 1,084 63.9

% chg 18.1 18.4 14.9 (2.7) 19.4 28.2 0.1 (5.7) 4.6 4.6 4.6 2.1 -

(42.2) (68.5) (28.8) (29.1) (29.1) (29.1) -

1,451 318 1,134 1,134 (27) 1,134 1,107 65.3

Exhibit 2: Actual vs. Estimates

(` cr) Net sales Other income Operating profit Interest Tax Net profit
Source: Company, Angel Research

Actual 2,865 26 429 10 83 363

Estimates 2,700 42 429 132 339

Variation (%) 6.1 (37.0) 0.0 (37.3) 7.1

Just-in- line revenue growth: DRL reported net sales of `2,865cr for 3QFY2013, registering 23.0% yoy growth, which was a tad lower than our estimate of `2,700cr. The U.S. and Emerging markets grew by 24% yoy (adjusted) were the key growth drivers for the company. The domestic market reported a strong growth of 12.0% yoy. In terms of market performance, the U.S. market reported strong growth of 38.0 %( adjusted) yoy, with sales of `924.0cr. ROW also registered a robust growth of 42.0% yoy to end the quarter at `155.6cr. Russia registered 32.0% yoy growth. The domestic market reported single-digit growth of 12.0% yoy. Sales from Europe de-grow by 20.0% yoy during the quarter. During the quarter, the company filed 4 ANDAs. The company has 65 ANDAs pending for approval with the USFDA, of which 35 are Para IVs and 8 are FTFs. During the quarter, DRL launched 8 products in the domestic market.

February 21, 2013

Dr. Reddys Laboratories | 3QFY2013 Result Update

Exhibit 3: Global generic trend

2,500 2,000 288 1,500 1,000 500 0 3QFY2012 Others 4QFY2012 Russia & CIS 1QFY2013 2QFY2013 3QFY2013 India Europe North America 1,111 301 212 268 275 201 873 227 316 155 927 332 333 243

(` cr)

249 294 169 792

924

Source: Company, Angel Research

The PSAI segment registered 28.0% yoy growth, majorly led by 50.0% yoy and 47.0% yoy in the Europe and India, respectively. US and ROW grew by 8.0% yoy and 13.0% yoy, respectively.

Exhibit 4: PSAI trend

800 700 600 500 221 188 71 165 75 3QFY2012 84 4QFY2012 Others
Source: Company, Angel Research

247 212 162 65 278 291 223 81 1QFY2013 Europe India 117 2QFY2013 North America 247 86 86

(` cr)

400 300 200 100 0

66

119 3QFY2013

February 21, 2013

Dr. Reddys Laboratories | 3QFY2013 Result Update

EBIT below expectations : DRL reported gross margin of 68.7% during the quarter. However, the companys EBIT margin came in at 15.0%. The key expenditure areas R&D grew by 34.2% yoy, while S&GA grew by 12.0% yoy during the quarter.

Exhibit 5: EBIT margin trend

32 28 24 26.7 19.2 14.6 15.0

(%)

20 16 12 8 4 0 3QFY2012

18.9

4QFY2012

1QFY2013

2QFY2013

3QFY2013

Source: Company, Angel Research

Adjusted net profit de-grew by 29.2% yoy during the quarter: DRL reported adjusted net profit of `363cr, registering an dip of 29.2% yoy, just-in line with our estimate of `339cr.

Exhibit 6: Adjusted net profit trend

550 500 450 400 350 343 336 363 513 494

(` cr)

300 250 200 150 100 50 0 3QFY2012 4QFY2012 1QFY2013 2QFY2013 3QFY2013

Source: Company, Angel Research

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Dr. Reddys Laboratories | 3QFY2013 Result Update

Concall takeaways
Gross Margins of PSAI is expected to normalize at around 30-35% in coming quarters. During 3QFY2013, R&D spend was higher at 7.1% of sales. Management expects similar trend to continue. FY2014 capex to be in line with FY2013 capex. Tax as a % of PBT is guided towards 20-22%.

February 21, 2013

Dr. Reddys Laboratories | 3QFY2013 Result Update

Investment arguments
Robust growth in the U.S. ahead: After attaining a critical mass (US$666mn in FY2012), DRL aims to scale up its business to the next orbit in the U.S. market on the back of a strong product pipeline (80 ANDAs are pending approval, of which 41 are Para IVs and seven are FTFs). Management has guided for robust growth in the U.S., driven by introduction of new products, some of which are also Para IV opportunities. Also, the company has developed its OTC product basket, which now contributes around US$130mn (FY2012), contributing almost 25% to its overall sales. Overall, we expect the ex-exclusivity U.S. sales to post a CAGR of ~18% during FY2012-14E. Domestic back in focus: After a below-industry average growth on the domestic formulation front since the last three years, DRL reported modest 11.0% growth in FY2012. Management expects the companys performance to rebound and targets to achieve 15% growth going ahead, driven by a) field force expansion and improvement in productivity, b) new product launches (including biosimilars) and c) focus on brand building. Strategic alliances to provide long-term growth: In order to tap the emerging market opportunities, DRL entered into an alliance with GSK in FY2011 to develop and market branded formulations across emerging markets. On the biogeneric front, the company has developed nine products (four products launched in India) on mammalian cell culture with global brand sales of US$30bn. The company has also entered into a marketing agreement with Valent Pharma to market Cloderm cream in the U.S. market. This deal is expected to provide an impetus to the proprietary products business going forward. Valuation: We expect the companys net sales to post a 9.8% CAGR to `11,662cr and adjusted EPS to record a 2.3% CAGR to `92.9 over FY2012-14E. DRLs growth would be driven by the U.S. business, uptick in the domestic formulation and Russian markets. At the CMP, the stock is trading at 22.4x FY2013E and 20.2x FY2014E earnings. We maintain our neutral view on the stock.

Exhibit 7: Key assumptions

FY2013E PSAI segment growth (%) Generics segment growth (%) Operating margin (%) Capex (` cr)
Source: Company, Angel Research

FY2014E 2.0 9.0 21.0 600

1.8 12.0 20.7 600

February 21, 2013

Dr. Reddys Laboratories | 3QFY2013 Result Update

Exhibit 8: One-year forward PE chart

2,500 2,000 1,500 1,000 500 0
Aug-08 Aug-09 Aug-10 Aug-11 Aug-12 Feb-08 Feb-09 Feb-10 Feb-11 Feb-12 Nov-08 Nov-09 Nov-10 Nov-11 May-08 May-09 May-10 May-11 May-12 Nov-12 Feb-13

Price

5x

10x

15x

20x

Source: Company, Angel Research

Exhibit 9: Recommendation summary

Company Alembic Pharma. Aurobindo Pharma Cadila Healthcare Cipla Dr Reddy's Dishman Pharma GSK Pharma* Indoco Remedies Ipca labs Lupin Ranbaxy* Sanofi India* Sun Pharma Reco Buy Accumulate Accumulate Accumulate Neutral Buy Neutral Buy Accumulate Accumulate Neutral Neutral Neutral CMP Tgt. price Upside (`) 73 182 741 382 1,878 86 2,098 60 473 590 413 2,256 779 (`) 95 208 817 419 155 78 559 655 % 28.4 14.3 10.4 6.1 64.9 27.9 16.5 10.1 7.7 13.0 18.8 18.3 20.2 5.6 25.5 7.8 12.7 18.8 12.8 25.7 26.1 FY2014E PE (x) EV/Sales (x) EV/EBITDA (x) 0.9 1.3 2.3 3.2 3.0 1.1 5.0 0.9 1.9 2.7 1.4 2.8 5.3 5.0 8.8 12.8 13.1 14.1 5.3 16.1 6.0 9.1 12.3 8.9 17.0 12.3 FY12-14E CAGR in EPS (%) 17.1 69.7 11.5 23.2 3.0 48.2 8.7 24.8 30.6 27.2 50.3 2.7 0.1 FY2014E RoCE (%) 29.4 10.7 17.2 19.1 15.1 10.4 38.9 14.6 25.7 24.9 29.7 12.5 27.6 RoE (%) 30.2 17.8 24.8 17.6 20.8 11.6 29.0 15.6 26.4 25.2 16.1 14.8 19.2

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 key therapeutic focus is on gastro-intestinal, cardiovascular, diabetology, oncology, pain management, anti-infective and paediatrics. The Key markets for DRL include India, USA, Russia and CIS, Germany.

February 21, 2013

Dr. Reddys Laboratories | 3QFY2013 Result Update

Profit & loss statement (IFRS Consolidated)

Y/E March (` cr) Net sales Other operating income Total operating income % chg Total expenditure Cost of revenues SG&A expenses R&D expenses EBITDA % chg (% of Net Sales) Depreciation & amortisation EBIT % chg (% of Net Sales) Interest & other charges Other Income (% of PBT) Share in profit of associates Recurring PBT % chg Extraordinary expense/(Inc.) PBT (reported) Tax (% of PBT) PAT (reported) Exceptional items PAT after MI (reported) ADJ. PAT % chg (% of Net Sales) Basic EPS (`) Fully Diluted EPS (`) % chg FY2010 7,028 56.9 7,085 2.4 5,608 2,978 2,251 379.3 1,420 (6.9) 20.2 416.0 1,004 (12.2) 14.3 37.2 36.9 3.5 4.8 1,066 6.3 860.3 205.3 98.5 48.0 106.8 815 106.8 921.4 4.1 1.5 54.6 54.6 3.8 FY2011 7,469 75.0 7,544 6.5 5,903 3,028 2,369 506.0 1,566 10.3 21.0 414.7 1,151 14.6 15.4 28.3 9.4 0.8 0.3 1,208 13.3 (37) 1,244.2 140.3 11.3 1,104 9 1,104 1,076 16.8 14.8 63.8 63.8 16.8 FY2012 9,674 76.5 9,750 29.2 7,340 3,862 2,887 591.1 2,334 49.0 24.1 481.3 1,853 60.9 19.2 (16.0) 5.4 1,951 61.5 104.0 1,846.6 420.4 22.8 1,426.2 1,426.2 1,506.5 40.0 14.7 88.8 88.8 39.4 FY2013E 10,696 76.5 10,773 10.5 8,483 4,291 3,464 727.4 2,214 (5.2) 20.7 522.0 1,692 (8.7) 15.8 5.4 1,773 (9.1) 1,773.4 353.6 19.9 1,419.8 1,419.8 1,419.8 (5.8) 13.3 83.7 83.7 (5.8) FY2014E 11,662 76.5 11,739 9.0 9,210 4,685 3,732 793.0 2,452 10.8 21.0 562.7 1,889 11.7 16.2 5.4 1,971 11.2 1,971.2 393.1 19.9 1,578.0 1,576.0 1,576.0 11.0 13.5 92.9 92.9 11.0

February 21, 2013

Dr. Reddys Laboratories | 3QFY2013 Result Update

Balance sheet (IFRS Consolidated)

Y/E March (` cr) SOURCES OF FUNDS Equity share capital Reserves & surplus Shareholders funds Total loans Deferred tax liability Total liabilities APPLICATION OF FUNDS Net fixed assets Goodwill /other intangibles Capital Work-in-Progress Investments Current Assets Cash Loans & Advances Other Current liabilities Net Current Assets Mis. Exp. not written off Total Assets 1,759 1,422 486.7 31.0 4,206 658.4 421.7 3,126 2,004 2,202 5,901 2,478 1,549 486.7 31.0 4,832 572.9 448.2 3,811 2,276 2,556 7,100 3,325 1,353 520.8 1,077 6,995 737.9 580.4 5,677 2,613 4,382 10,659 4,125 1,353 520.8 1,077 7,620 730.1 641.8 6,248 2,876 4,744 11,821 13,139 4,925 1,353 520.8 1,077 8,770 2,037 699.7 6,034 3,510 5,261 84.4 4,207 4,292 1,465.6 143.8 5,901 84.4 4,515 4,599 2,357.2 143.8 7,100 84.8 5,660 5,744 4,831.2 83.3 10,659 84.8 6,820 6,907 4,831.2 83.3 11,821 84.8 8,137 8,225 4,831.2 83.3 13,139 FY2010 FY2011 FY2012 FY2013E FY2014E

Cash flow statement (IFRS Consolidated)

Y/E March (` cr) Profit before tax Depreciation (Inc)/Dec in Working Capital Less: Other income Direct taxes paid Cash Flow from Operations (Inc.)/Dec.in Fixed Assets (Inc.)/Dec. in Investments Other income Cash Flow from Investing Issue of Equity Inc./(Dec.) in loans Dividend Paid (Incl. Tax) Others Cash Flow from Financing Inc./(Dec.) in Cash Opening Cash balances Closing Cash balances FY2010 1,065.6 416.0 (38.0) 36.9 98.5 1,308.2 (157.7) 4.8 36.9 (116.0) 0.2 (482.7) 123.3 (734.2) (1,093.4) 98.8 559.6 658.4 FY2011 1,207.7 414.7 (439.0) 9.4 140.3 1,033.7 (718.3) 9.4 (708.9) 891.6 221.1 (1,080.7) (410.3) (85.5) 658.4 572.9 FY2012 1,950.6 481.3 (1,661.4) 420.4 350.2 (881.2) (1,046.3) (1,927.5) 0.4 2,474.0 259.3 (472.4) 1,742.3 165.0 572.9 737.9 FY2013E 1,773.4 522.0 (369.3) 353.6 1,572.5 (800.0) (800.0) 259.3 (521.0) (780.3) (7.8) 737.9 730.1 FY2014E 1,971.2 562.7 790.2 393.1 2,930.9 (800.0) (800.0) 259.3 (564.7) (824.0) 1,306.9 730.1 2,037.1

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Dr. Reddys Laboratories | 3QFY2013 Result Update

Key ratios
Y/E March Valuation Ratio (x) P/E (on FDEPS) P/CEPS P/BV Dividend yield (%) EV/Sales EV/EBITDA EV / Total Assets Per Share Data (`) EPS (Basic) EPS (fully diluted) Cash EPS DPS Book Value Dupont Analysis EBIT margin Tax retention ratio Asset turnover (x) ROIC (Post-tax) Cost of Debt (Post Tax) Leverage (x) Operating ROE Returns (%) ROCE (Pre-tax) Angel ROIC (Pre-tax) ROE Turnover ratios (x) Asset Turnover (Gross Block) Inventory / Sales (days) Receivables (days) Payables (days) WC cycle (ex-cash) (days) Solvency ratios (x) Net debt to equity Net debt to EBITDA Interest Coverage (EBIT / Int.) 0.2 0.6 27.0 0.4 1.1 40.7 0.7 1.8 0.6 1.9 0.3 1.1 4.1 69 68 50 81 3.6 71 72 55 85 3.4 66 80 45 105 2.9 74 81 50 130 2.6 75 82 51 113 16.2 30.4 21.7 17.7 29.4 24.2 20.9 29.6 29.1 15.0 19.6 22.4 15.1 20.5 20.8 14.3 52.0 1.3 9.4 1.1 0.3 11.6 15.4 88.7 1.3 17.5 1.3 0.3 22.2 19.2 77.2 1.2 17.5 -0.3 0.6 27.4 15.8 80.1 1.0 13.0 0.0 0.7 21.5 16.2 80.1 1.1 13.7 0.0 0.5 20.1 54.6 54.6 31.0 5.0 254.2 63.8 63.8 90.0 11.0 272.5 88.8 88.8 112.5 14.0 338.8 83.7 83.7 114.5 14.0 407.3 92.9 92.9 126.1 14.0 485.1 34.4 60.6 7.4 0.3 4.6 22.9 5.5 29.5 20.9 6.9 0.6 4.5 21.4 4.7 21.1 16.7 5.5 0.7 3.7 15.4 3.4 22.4 16.4 4.6 0.7 3.4 16.2 3.0 20.2 14.9 3.9 0.7 3.0 14.1 2.6 FY2010 FY2011 FY2012 FY2013E FY2014E

February 21, 2013

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Dr. Reddys Laboratories | 3QFY2013 Result Update

Research Team Tel: 022 - 39357800

E-mail: [email protected]

Website: www.angelbroking.com

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Disclosure of Interest Statement 1. Analyst ownership of the stock 2. Angel and its Group companies ownership of the stock 3. Angel and its Group companies' Directors ownership of the stock 4. Broking relationship with company covered

Dr. Reddys Laboratories No No No No

Note: We have not considered any Exposure below ` 1 lakh for Angel, its Group companies and Directors

Ratings (Returns):

Buy (> 15%) Reduce (-5% to -15%)

Accumulate (5% to 15%) Sell (< -15%)

Neutral (-5 to 5%)

February 21, 2013

11