Divis Laboratories Ltd is on a roll, clocking revenue growth of 90% and profit growth of 172% for the year ended March. Based on the company’s performance in the first nine months of the year, it was evident that FY07 was going to be special for Divis.
But even the most optimistic analyst hadn’t foreseen the huge jump in growth in the fourth quarter. Sales grew by 99% and profit jumped 341%, aided by a surge in the company’s custom manufacturing business. In FY06, custom manufacturing for innovator companies accounted for 30% of the company’s sales. In the first nine months of the fiscal, this rose to 41-42%. But in the March quarter, sales from custom manufacturing jumped to 65% of revenues.
Divis works with 20 of the world’s top 40 innovator companies, and its custom manufacturing work involves high margins. It’s no wonder that operating margin leaped nearly 15 percentage points to 45% last quarter. The performance in the March quarter, however, seems to be an aberration. L. Kishore Babu, CFO of Divis, says that in FY08, custom manufacturing is expected to account for 50% of sales.
But even that seems good enough for the markets. The Divis stock rose 17% after the results were announced, taking its one-year gain to 232%. In comparison, the Bombay Stock Exchange’s health-care index has risen just 7% in the past year, pulled down by the lacklustre performance of generics manufacturers.
Divis, too, manufactures active pharmaceutical ingredients for generics, but it steers clear of patented products. This has increased its credibility with innovator companies, which have increased their outsourcing work to Indian firms since 2005. Besides, Divis increased its capacity by more than 60% with a capex of Rs188 crore last year. This, too, contributed to the unusually high growth last year.
Babu expects sales growth to moderate at about 25% this financial year. Earnings growth may not be very different, since the company expects the high-margin custom manufacturing business to remain at 50% of revenues. That makes Divis 32 times trailing PE valuation look expensive. But then, after the positive surprise last quarter, the markets seem to be betting that Divis would easily beat its targets.
In spite of Wockhardt Ltd’s acquisition of French company Negma Lerads being the first of its kind in terms of an Indian pharma company acquiring a company with patented products and despite it being widely acknowledged that the acquisition has come at a reasonable price, the Wockhardt stock has gone the way of all acquirers, losing ground since announcing the deal. Even the US Food and Drug Administration’s approval for marketing Zolpidem, a brand of sleeping pills, hasn’t helped the stock.
Consider the positives. Negma has as many as 172 patents and a range of products in the pipeline, it provides Wockhardt with an entry into the French market, it could use Negma to launch generics in that market, or to in-licence products of other manufacturers. Wockhardt could cut costs by consolidating Negma’s operations with those of its other European acquisitions. And all these possibilities have been acquired, the management says, at a price that will not lead to lower earnings per share this year.
Wockhardt’s March quarter results have also been good, with strong year-on-year growth in revenues as well as net profit. However, acquisitions make comparisons difficult. Much of the revenue and profit growth in Europe, for instance, has been due to the acquisition of Pinewood Laboratories last October. Similarly, sales and profits in India have been boosted by the acquisition of Dumex India.
The reasons for the market’s caution appear to be lack of clarity about the precise benefits that the Negma acquisition will bring. The appreciating rupee and pricing pressures in Europe have also been cited as dampeners.