Divi’s Laboratories: BUY. Divi's Laboratories: Sample of success

It’s been a roller coaster ride for Indian equities so far this year, due to concerns over the slowdown in China and uncertainty regarding the US Fed’s rate move.

But pharma stocks have bucked the weakness. The BSE Healthcare Index has gained almost 23 per cent since January this year, even as the Sensex lost about 2 per cent during this period.

Steady performance in the home market, healthy growth in key overseas markets such as the US and a weak rupee against the dollar have kept investor interest intact in pharma stocks.

After a modest performance in 2014-15, the contract research and manufacturing major Divi's Laboratories seems set to post healthy growth over the next two to three years.

First, Divi’s Labs has indicated that it has commenced custom synthesis assignment for a multinational drug maker. This should provide a leg-up to the company’s profitability in the coming quarters.

Next, ramp up at the company’s DSN SEZ at Visakhapatnam should add to revenues in 2016-17.

Also, Divi’s Labs’ new plant at Kakinada, Andhra Pradesh, is expected to commence operations by mid 2016-17; this should support growth in the medium term. Finally, contribution from the company’s carotenoids business, which enjoys healthy profit margin, is expected to increase significantly in the near term.

Valuations are attractive too. The Divi’s Labs stock currently trades at about 21 times its 2016-17 estimated earnings; this implies an over 10 per cent discount to the BSE Healthcare Index. Investors with a two to three year horizon can buy the stock.

The company reported revenue and operating profit growth of 26 per cent and 28 per cent respectively in the June quarter over the same period last year. Divi’s reported 21 per cent growth in revenue from the custom synthesis segment during the June quarter.

The custom synthesis order from a multinational pharma company, which commenced in the first quarter of the fiscal, helped the healthy growth in Divi’s profit. As part of its custom synthesis segment, Divi’s helps multinationals in process development and optimisation for innovative molecules. The company also undertakes large scale manufacturing of these products, once they are approved.

Given the attractive profit margin in this segment, higher contribution from the custom synthesis business in the coming quarters should boost the company’s profitability.

Active pharma ingredient sales grew 34 per cent during the April-June 2015 period compared with the same period last year.

Divi’s Labs has steadily increased production at its Visakhapatnam facility (DSN SEZ) — blocks 3, 4 and 5. The plant is currently operating at about 90 per cent capacity utilisation.

Ramp up in production at the DSN facility should help the company sustain growth over the next two years. Also, the company has firmed up plans to set up a new facility at Kakinada (Andhra Pradesh); statutory approvals for the same are underway. The total spend is expected to be around ₹500 crore, which will be largely funded by internal accruals.

The first phase of the plant is expected to be completed by early 2016-17 and production to commence by mid 2016-17.

Given that the management has historically adopted a cautious stance with respect to capital expenditure, the ongoing expansion exercise signals healthy demand and growth prospects over the medium term.

The company’s caroteniods segment grew at a docile 5 per cent in the June quarter recording revenue of ₹45 crore.

Divi’s Labs’ management expects this business to contribute ₹250 crore to the company’s consolidated revenues in 2015-16.

Besides, depreciation of the rupee against the dollar should have a positive rub off on the company’s profitability, given that almost 80 per cent of its exports billing is in dollars. Exports accounted for 87 per cent of the company’s 2014-15 revenue.

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