The Hindu Business Line : Divi’s Laboratories: Buy

Investors with a long-term perspective can accumulate the stock of Divi’s Laboratories, which is a key player in the global pharmaceutical outsourcing market.

The company has well-established working relationships with a number of the top 20 global innovator firms. Its healthy return ratios, strong position in niche segments and the likely revenue trigger from its entry into the nutraceuticals segment are also positives.

Its valuations also appear reasonable given the growth potential. At the current market price of Rs 565, the stock trades at about 16 times its likely FY11 per share earnings.

There has been a revival in demand from the global pharma companies in recent times, after the massive inventory de-stocking which followed the credit crisis.

While the impact of the inventory rationalisation is expected to spill over to the current quarter’s numbers too, the company’s performance in the second half of the year is likely to be much better. Investors, therefore, can use any weakness in the stock’s price following its September quarter earnings announcement to accumulate it.

Though Divi’s has seen a balanced revenue contribution from both its segments — generic APIs (active pharma ingredients) and custom chemical synthesis of APIs — its custom synthesis segment may see a greater traction in the coming years.

This segment, led by increasing volume in late stage projects from innovator firms, is expected to drive the growth from hereon. Increasing competition from generic companies and cost pressures on global pharma majors may catalyse this trend. Divi’s has also scaled up its filings and products.

In FY09 alone it filed five DMFs (drug master files) with the USFDA, bringing the total up to 37. Its entry into the nutraceuticals segment (dietary supplements used to fill nutritional deficiencies in food and to prevent diseases) with the launch of products under brand name ‘Vivital’ also holds potential.

But what perhaps holds the key to growth is the extent of revival in demand from the global pharma players. Their de-stocking of inventories across supply chain earlier had clearly taken a toll on Divi’s first quarter numbers, with revenues declining 19 per cent over the year.

Poor operating performance, with margins declining 5.5 percentage points to 36 per cent and higher tax provisions (for SEZ profits of earlier year) further pressured profits.

To put this in perspective, while profit before tax was down 33 per cent, post tax the decline was steeper at 95 per cent. But the outlook is now beginning to appear brighter, with demand likely to pick up in the second half of the current year and normalise from the next fiscal.

Srividhya Sivakumar