Home / Markets / Mark To Market /  Waning covid tells on health of Divi Labs stock

The stock of Divi’s Laboratories Ltd has lost its charm this year. The stock fell by nearly 9% on Monday after the company’s September quarter (Q2FY23) results fell far short of the Street’s expectations. Tuesday was a stock market holiday because of Guru Nanak Jayanti. The stock has lost 27% so far in CY22, more than wiping out the gains seen in CY21.

The business momentum of Divi’s Laboratories seems to be waning after a stellar run over the past two years, which was aided by capacity expansion and covid projects, pointed out analysts from Nuvama Research

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With receding coronavirus cases, the drop in sales of covid antiviral drug molnupiravir weighed heavily on Q2 custom synthesis (CS) revenues. Divi’s manufactures generic active pharmaceutical ingredients (APIs) and is also present in the CS business, which contributed 43% of the company’s Q2 revenue.

Container shortages also hurt the segment in Q2 with the magnitude of drop in CS revenues being sharper than foreseen. Poor performance here was a pain for overall revenues even as the generics segment put up a decent show, though that was not enough. Consolidated revenue fell by 6.7% year-on-year (y-o-y) 1,854.5 crore, lower than consensus estimates. This is the first decline in Divi’s revenue in the last 20 quarters, said analysts from Nuvama.

Operating deleverage coupled with high energy costs meant that the Ebitda (earnings before interest, taxes, depreciation and amortization) margin fell fast. The metric declined by as much as 767 basis points (bps) y-o-y to 33.5%, the lowest in the past ten quarters. One basis point is 0.01%. Margin contraction is steeper than the 590bps drop seen in Q1.

In keeping with the Q2 performance, analysts have slashed their earnings estimates for FY23 and FY24.

The margin outlook is also not encouraging. Divi’s would benefit from backward integration, but the costs of some inputs remain high and energy prices are also still high. “The Q2 margin is more representative of what Divi’s generally generates. The company is reverting to normalized range after seeing a boost from the covid drug. We expect this level of margin to continue in the upcoming quarters," said an analyst, requesting anonymity.

There are also concerns on growth. “Given the high covid base in FY22, we expect flat profit after tax compound annual growth rate over FY22-25E," said analysts from Prabhudas Lilladher in a report on 8 November. In FY22, Divi’s net profit rose by 49% y-oy to 2,960 crore, whereas in the first half of FY23 net profit has risen by nearly 3% y-o-y to 1,195.6 crore.

The generic API business continues to be plagued by pricing pressures. However, with the advent of winter season, demand for cough and cold medicines would gain traction, which is a positive. The CS business has growth opportunities in phase 2 and 3, but these can be expected to play out over the next 4-6 quarters and the exact benefits are uncertain at this stage. Meanwhile, there has been no further progress on the Kakinada plant and Divi’s is still waiting for government clearance.

Against this backdrop, the subdued outlook in the foreseeable future is likely to keep sentiments muted for the stock. It does not help that the valuations are not exactly cheap. Prabhudas Lilladher has downgraded the rating on Divi’s shares to ‘Hold’ from Accumulate with a revised target price of 3,300 per share ( 4,100 earlier) valuing the stock at 32 times price-to-earnings multiple for September 2024E. On Monday, Divi’s shares closed at 3,414.55 apiece.

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Vineetha Sampath

Vineetha Sampath is a chartered accountant and is experienced in the field of research analysis. She joined Mint's Mark to Market team recently and this is her first stint in journalism.
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