Brokerages raise Dr Reddy’s EPS estimate, but upside looks capped

Dr Reddy’s acquisition of branded generics of Wockhardt is expected to be marginally EPS accretive in about two years. Analysts have raised their EPS estimate by up to 3 per cent for FY22, but current valuation of Dr Reddy’s at 20 times forward earnings leaves little room for immediate gains.

Shares of Dr Reddy’s rallied 34 per cent in the last six months. They ended 4 per cent higher at Rs 3,326.3 on Thursday. The pharma major announced the acquisition of select divisions of Wockhardt’s domestic portfolio for a consideration of Rs 1,850 crore in cash, which is four times FY20 estimated sales and 15 times of Ebitda.

“Despite presence in high-growth therapies, the weighted average molecule growth of the acquired portfolio is low to mid-single digits, and despite initial cost synergies, we expect the acquisition to be marginally dilutive for FY21 and FY22,” said Chirag Talati, analyst, Kotak Securities. “Post the recent run-up, the stock trades at 12 times FY21 estimated EV/Ebitda and 23 times FY21 EPS, pricing the stock to perfection, with limited room for execution slip-ups”.

Analysts expect the acquisition to be funded through a bridge loan, with quick de-leveraging by FY22 through internal accruals. Given the low growth rate of the portfolio, even assuming 500bps margin expansion, assuming a 12 year amortisation schedule, analysts believe the acquisition will be EPS dilutive to neutral at best, depending on the yield assumed on existing cash balance.

“We raise our EPS estimates by 3 per cent for FY22 to factor in the earnings prospects from this acquisition” said Tushar Manudhane, analyst, Motilal Oswal Financial Services. “We estimate 13 per cent earnings CAGR over FY19-22 led by superior execution in the US/India/China and other key geographies. We continue valuing DR Reddy’s at 20 times 12 months forward earnings to arrive at a price target of Rs 3,100”.

The company which maintained a healthy dividend payout of 25.92 per cent is currently trading at 3.45 times its book value. It has a low return on equity of 10.37 per cent for the past three years. Dr Reddy’s earnings were on a downtrend over the past three years with 8 per cent compounded decline over FY16-19 largely due to intensifying competition in its products, which impacted gross margins. However, controlled operating expenses led to sharp 63 per cent YoY earnings growth in FY19, partly off a low base.

“Assuming 25 per cent Ebitda margin for the acquired business, we estimate the acquired business could add earnings per share of Rs 5 without factoring in any synergies” said Kunal Dhamesha, analyst, SBICAP Securities. “Any cost synergies arising out of common sales and marketing expenses, distribution expenses etc. would be accretive to our estimates”.