Why Divi’s Lab short-term outlook is cloudy

Divi’s shares are down 5.5% since Friday when Q1 earnings were announced, taking the y-o-y drop in the stock to 20% vis-à-vis the 9% drop in the Nifty Pharma index. Photo:
Divi’s shares are down 5.5% since Friday when Q1 earnings were announced, taking the y-o-y drop in the stock to 20% vis-à-vis the 9% drop in the Nifty Pharma index. Photo:


  • Divi's Laboratories fared well on the revenue front in Q1FY23, but Ebitda margin was at a nine-quarter low due to cost inflation

After a good run in financial year 2022, Divi’s Laboratories Ltd has two main problems to grapple with. One, the benefits it saw from the pandemic are set to wane with the expected drop in the sales of covid antiviral drug, molnupiravir, revenues of which are included in the company’s custom synthesis (CS) business. Divi’s manufactures generic active pharmaceutical ingredients (APIs) and is also present in the CS segment.

Against this backdrop, some analysts expect fiscal year 2023 (FY23) revenue from the CS segment to be lower than the previous year on the back of a high base. Some of this pain is already visible, with CS revenues falling sequentially in the June quarter (Q1FY23). Divi’s has completed all molnupiravir orders it had received and is discussing further orders, the management told analysts in the post-earnings call.

Under the weather
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Under the weather

Additionally, the overall near-term earnings outlook is muted. “Divi’s two large custom synthesis projects, which are multi-year, will start delivering commercial quantities only after 1-2 years. Another major growth driver for the company is new generics expiring between 2023-2025, which are currently worth $20 billion. Sales from these new generics are still at least one year away as the patents have yet to expire," said analysts from Jefferies India in a report on 15 August. “Divi’s is also trying to scale up its sartan (used to treat high blood pressure) business, which we believe will require more time to make a major financial impact," the broking firm said.

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The generics (excluding nutraceuticals) business, which formed nearly 39% of Q1 revenue, is improving but may not compensate on an overall basis. “Recovery in generic APIs is unlikely to help bridge the gap from lower molnupiravir sales henceforth resulting in just 2% earnings per share compound annual growth rate over FY2022-25E," according to Kotak Institutional Equities.

Divi’s existing and upcoming capacities would meet near-to-medium term requirements. Capacity utilization is 83%. However, the Kakinada project is vital and the delay there has weighed on investor sentiments. The company is still waiting for land transfer from the Andhra Pradesh government. Excluding this project, Divi’s expects capex not to exceed 500-600 crore in FY23.

Divi’s second problem is that margin woes remain. “The upcoming quarters will see margin pressures, limiting the upgrades in its earnings estimates," said Surya Patra, an analyst at PhilipCapital (India). Divi’s fared well in terms of revenues in Q1, but the margin show was nothing to write home about, with cost pressures and logistical headwinds weighing on profitability. For perspective, earnings before interest, tax, depreciation, and amortization (Ebitda) margin in Q1 dropped to a nine-quarter low of 37.6%. The metric is down 630 basis points (bps) sequentially and 590 bps year-on-year (y-o-y). One basis point is 0.01%.

Divi’s shares are down 5.5% since Friday when Q1 earnings were announced, taking the y-o-y drop in the stock to 20% vis-à-vis the 9% drop in the Nifty Pharma index. However, it’s not like valuations are undemanding. Bloomberg data shows the stock is trading at almost 34 times the estimated earnings for FY24.

“Divi’s mid- to long-term prospects appear to be good given its readily expanded capacities for manufacturing products at a time of supply disruption from China and when global pharma companies aim to de-risk from the Chinese supply chain," Patra said. It has also entered into a contract with a big pharma company in contrast media and is expanding into new areas. However, in the near-term, triggers for meaningful outperformance in Divi’s stock are few and far between.

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