Divi’s Labs: Buy

Improving growth prospects, likely expansion in margins and negligible debt on books make the stock of Divi's Laboratories an attractive buy for the long term. An established player in the global pharmaceutical outsourcing market, Divi's seems to have come off well from the phase of inventory destocking by MNC pharma.

Pointing at clear signs of recovery is its improved performance in the first half of the current fiscal. At the current market price of Rs 739, the stock trades at about 19 times its likely FY12 per share earnings.

While this is at a slight premium to its peers, the company's financial parameters justify it. Thanks to its established working relationships with a number of the top 20 global innovator firms, Divi's is much better-positioned to grow its revenues and profits than most of its peers.

Diversified presence

Having a diversified revenue basket and customer mix not only spreads the risk, it also opens up growth opportunities for the company.

Divi's derives a good part of its revenues from exports (93 per cent), predominantly from the regulated markets of North America and Europe (45 per cent and 30 per cent of FY11 sales, respectively). In addition, it has a diversified products range, with the largest product making up for 20 per cent of sales (in FY11); top five products made up over 52 per cent of sales last year.

Its customer base too is equally spread out, with the top five contributing to about 47 per cent of its revenues.

What's also encouraging is that, over the year, Divi's has seen a drastic rise in product launches. In FY-11 alone, it added 21 products to its product portfolio, of which eight were generic APIs and intermediates, while 13 were custom synthesis APIs and intermediates.

At the end of March 2011, Divi's had a pipeline totalling 41 Drug Master Files with the US FDA and Certificate of Suitability for 12 products with the European Directorate. Such a robust product pipeline promises to keep its growth momentum going.

Growth drivers

Aside of its product pipeline, the company's growing presence in the carotenoids segment too presents a fairly big growth opportunity (market size estimated to be about $1 billion with 2-3 major players only). Though the revenue contribution from this business is not very significant now, the growth prospects make the business attractive. Further, commencement of operations at its new multi-purpose plant at Vizag too would aid growth.

Given that operations started in June 2011, meaningful contributions from the facility can be expected from FY12 onwards. That Divi's is planning to incur a capex of about Rs 175 crore for the year to address capacity shortfalls too reflects the improving business landscape.

Result highlights

For the quarter ended Sep-2011, Divi's managed to grow its sales by about 43 per cent to Rs 366 crore. While a lower base would have helped here, sales growth was helped by a favourable product mix as well as the commissioning of the new SEZ plant at Vizag.

The company reported a decent growth in the Carotenoids business, what with its revenues going up by about 50 per cent to Rs 22 crore during the quarter (Rs 38 crore for the half year).

As a result, operating margins expanded by about 340 basis points to 37.8 per cent. For the coming quarters, margin can be expected to remain at similar levels, given the likely improvement in utilisation and steady up tick in contributions from the high-margin carotenoids segment.

Profit growth for the quarter, however, was capped at 45 per cent to Rs 106 crore, mainly due to a sharp rise in effective tax rate.

The tax outgo increased drastically as the tax exemption for its EOU (export-oriented unit) expired by March-2011; its older SEZ unit is in the 50 per cent tax exemption bracket. The new DSN SEZ unit, however, would be eligible for full exemption of export profits for five years from April 2011 onwards.

The management had earlier given a sales growth guidance of 25 per cent for the year.

Considering that the sales for the first half grew by over 40 per cent, the company seems well-placed to meet its growth target. Consolidation in the global pharma space and currency fluctuations, however, may pose a risk.

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