>DR REDDY'S LABS (MERRILL LYNCH)

In good health; Rate Buy......

■ Reinstate coverage with Buy rating; 25% upside potential
We reinitiate coverage of Dr Reddy’s Laboratories (DRL) with a Buy rating and PO of Rs714. We forecast 20% EPS CAGR over FY09-11, and core EPS CAGR of 49%. At PO, stock would trade at 15x FY11E core EPS, which is a slight premium to peers. Near-term triggers include possible surprise on management guidance later this week, and likely launch of Omeprazole OTC in H2 FY10.

■ Forecast revenue to grow 11% annually
We expect growth in global generics (~70% of DRL) driven by new products and market share gains, and revamp of supply-chain (in India), even as our forecasts factor continuing pressure in EU (~13%). Based on management indication, we see upside risk to Para IV exclusivities/niche opportunities. In the PSAI segment (~30%), we expect API (ingredients to formulators) to maintain ~13% annual growth on DRL’s sizeable portfolio of filings, and focus on customs manufacturing (rather than slowing customs synthesis), to drive recovery towards 2H FY10.

■ Stable margin estimates, but may be conservative
Following an expected spike to 18.5% in FY09, we estimate margins at around 18%, restricted by our conservative revenue assumptions for high contribution opportunities with limited competition. However, we expect base margins to rebound around 30% (or 400bps) on improved revenue and mix to higher contributing markets, ie, Russia, US and India.

■ Valuations attractive in our view
Despite a 27% YTD stock rally, we believe valuations are attractive, given strong 49% core EPS CAGR, compared with domestic peers at 21% CAGR (consensus), as well as global counterparts (14% CAGR). On 2-year price to earnings growth (PEG), DRL trades at 0.3x, which is 60% discount to domestic peers.

To see full report: DR REDDY'S LABS