Divi’s Labs results for Q4FY08 were marginally ahead of estimates, despite a high base in Q4FY07. Sales were bolstered by increasing traction in the Custom Chemical Services (CCS) segment where the company enjoys healthy relationships with 20 of the top 25 innovator companies.
The generic API business is also going strong with new product introductions and consolidation of market share for existing products. EBITDA margins at 41.5% were ahead of estimates.
Divi’s mega capex of Rs2.5 billion executed over FY05-FY07 has generated significant value in FY08. Capacity expansion in CCS has enabled higher contract execution while a focus on niche, difficult to manufacture APIs has resulted in market leadership for key products.
Infrastructure for the launch of carotenoids, a $1 billion opportunity for the company, has been newly commissioned. Carotenoid sales are estimated to contribute 3% to consolidated sales in the first nine months of FY09.
Divi’s remains our preferred pick in the Indian CRAMS space, given its healthy relationship with top innovators amid a growing outsourcing trend. Through its focus on high-margin CCS, the company’s EBITDA margin will remain amongst the highest in the CRAMS segment.
Further, as Divi’s emerges from its heavy capex phase, we expect return ratios to improve significantly. We estimate a PAT CAGR of 28% to Rs6 billion over FY08-FY10, and maintain BUY with a target price of Rs1,833.