Home / Markets / Mark To Market /  Divi’s Laboratories’ strong business prospects come at pricey valuations

The differentiated and niche business model of Divi’s Laboratories Ltd has caught investors’ fancy. The firm’s shares have almost doubled in the past one year, compared with the gains of around 63% in the Nifty healthcare index.

The reason for the euphoria lies in the increased growth opportunities in the API (active pharmaceutical ingredients) and CRAMS (contract research and manufacturing services) space. The shift in focus of global pharmaceutical manufacturers to other destinations to reduce dependence on China has paved the way for fresh opportunities.

Divi’s has a successful track record of executing the custom synthesis business for innovator customers, and being one of the largest generic API manufacturers globally, it has been among the large beneficiaries of this trend. Its longstanding relationships with customers, cost competitiveness and innovation strengths are also some of the reasons that make it a preferred play.

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However, after a strong run-up in the stock, valuations have turned expensive, too. The company will need to maintain a decent growth trajectory for a long time to justify valuations of 42 times FY22 estimated earnings.

The company only manufactures select APIs with high complexities and ensures limited competition. The focus on limited products also brings cost advantages that ensure good margins. Besides, it remains a preferred choice for large pharmaceutical manufacturers. It is also the preferred choice in the CRAMS segment, enjoying a strong relationship with six of the top 10 big pharma companies, said analysts.

The company had reported 26% year-on-year (y-o-y) growth in sales for API generics business during Q2 that was led by improved demand, de-bottlenecking and capacity expansions. Further, more expansions from the already committed capex are to come onstream in H2.

Targeting urgent demand for custom synthesis, the company had announced additional capex too (to be completed in 6-9 months). In December, it had announced the commencement of the construction of Divi’s Laboratories Unit-III facility near Kakinada in Andhra Pradesh (first phase to start operations in 12-18 months).

PhillipCapital India Research analysts said: “The new capacity additions practically have eliminated our medium-term concern of capacity constraint (emerging from recent robust growth momentum) and provide strong growth visibility over the next five years."

Of course, the timely completion of expansions is necessary for meeting the high growth expectations from the Street. For the December quarter, Motilal Oswal Financial Services analysts expect sales to grow 27% and profits to grow 48.8% year-on-year, which is even better than the Q2 performance. The valuations, however, leave little room for error on meeting these expectations

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