Divi's Labs

Investors with a long-term perspective can consider accumulating the stock of Divi's Laboratories, an established player in the global pharmaceutical outsourcing market. Divi has well-established working relationships with a number of the top 20 global innovator firms. With global pharma companies beginning to restock inventories, it will only be a matter of time before it reflects in the company's financial performance.



Divi's presence in the high-growth high-margin carotenoids and stronghold in niche segments too make a case for investing in it. Given this background, the stock's valuations seem reasonable and leave room for long-term growth. At the current market price of Rs 755, it is priced at about 22 times and 18 times its estimated FY-11 and FY-12 per share earnings. Though this is at a premium to some of its peers, Divi's healthy return ratios justify it.

Improving demand

The company now stands to benefit from the turning tide of MNC pharma companies beginning to restock. Divi's long-standing relationship with these companies affords it a good position to benefit from the improving business demand. The management expects a normalisation in demand for custom manufacturing this year onwards. That the company reported a consolidated sales growth of 28 per cent in the June quarter corroborates the recovery in order flow. Divi's has earmarked a capital expenditure of Rs 200 crore towards setting up a new SEZ to create capacities in generic as well as custom synthesis segments. That the company expects its existing capacities to near full utilisation by the end of next financial year, by when the SEZ is likely to be completed, too reflects positively on the demand front. Notably, the capex last year was only Rs 54 crore.

Diversified presence

Divi's continues to see a balanced revenue contribution from its two segments — generic APIs (active pharma ingredients) and custom chemical synthesis of APIs. In addition, it has a diversified products range, with the largest product making up for 18 per cent of sales (in FY10); top five products made up over 55 per cent of sales last year. Its customer base too is equally spread out, with the top five contributing to about 49 per cent of its revenues. A well-diversified product and customer mix may explain the company's relatively high margins last year. Divi's reported a high operating margin of about 45 per cent in spite of a challenging year.

This show of strength too reflects positively on its standing in the market. In terms of product addition, it added seven products to its product portfolio last year, of which two were generic APIs and intermediates, while the rest were custom synthesis APIs and intermediates.

The company derives a good part of its revenues from exports, predominantly from the regulated markets of the US and Europe (52 per cent and 27 per cent of FY10 sales, respectively). Its robust product pipeline promises to keep the growth momentum going. At the end of last year, Divi's had a pipeline totalling 38 Drug Master Files with the US FDA and Certificate of Suitability for 10 products with the European Directorate.

Growth potion

While improving demand for custom manufacturing is a big positive, it is the company's growing presence in carotenoids that holds the potential to become its next significant growth driver. Carotenoids, which include a group of pigments that are used as anti-oxidants in the food processing and pharmaceutical industry, presents a fairly big growth opportunity for the company (market size estimated to be about $1 billion with 2-3 major players only). In the quarter ended June 2010, Divi's reported Rs 18 crore revenues from this segment (Rs 13 crore in March 2010 quarter). The management expects to make Rs 75 crore this year, twice what the segment made last year .

Margins to improve

In the June quarter, a revenue mix skewed towards generic API sales resulted in lower operating margins of 38 per cent. With a higher share of custom synthesis revenues likely in the coming quarters, margins can be expected to go back to 44-45 per cent levels. Likely improvement in utilisation and higher contributions from the carotenoids segment are also positives. Profits grew 44 per cent in the quarter.

via BL