Divi's Laboratories: High on hopes

Positive outcome of ongoing plant inspection can lead to more gains

Divi’s Laboratories’ share price rose almost 15 per cent at Rs 829 in two trading sessions, as investors remain hopeful on the prospects of the company’s Unit II at Visakhapatnam, which is under inspection of the US drug regulator (USFDA).

The FDA had issued an import alert in March 2017.

The plant contributes almost 65 per cent to Divi’s consolidated sales (over half to US sales), and is crucial for the company’s growth.

Analysts, however, caution against a premature celebration.

The import alert had dealt a severe blow to the Street’s sentiment as well as to the company’s performance, even as the FDA thereafter allowed some products to be imported.

According to analysts, a severe remediation process has to be taken to overcome the deficiencies observed, which might take long for the resolution of issues. The June quarter results bore the brunt of the import alert. While sales declined 19 per cent, operating and net profit fell by about 40 per cent each year-on-year.

The recent optimism, however, seems valid looking at certain developments.

The company got a breather in July with the FDA lifting the import alert under Clause 99-32 (related to insufficient inspection at first instance), while continuing it under Clause 66-40 (pertains to current good manufacturing practices).

Also, inspections at Unit II by Irish and Slovenian drug regulators, which ended in August, have gone without any observations. The ongoing inspections are believed to be happening after Divi’s completing the remedial measures. Therefore, the Street’s hope of a positive outcome and consequently better earnings has some backing.

Analysts, after the June quarter results, had indicated towards a flat earnings growth in the coming quarters. Emkay Global had expected Divi’s earnings trajectory to be largely flat over the next two years. HDFC Securities foresee two per cent revenue and five per cent earnings CAGR (compounded annual growth rate) over FY17-20.

These estimates could be revised if Divi’s gets a green signal from the FDA. An analyst at a domestic brokerage said there could be another 15 per cent upside to the stock price if the plant gets a clearance.

However, investors need to be cautious.

The analyst quoted above says resolution of an import alert takes about two years, so patience could prove be rewarding. Also, the company’s Unit I is pending a re-inspection by the USFDA, which is likely to take place in a couple of weeks. Thus, one should opt for a wait and watch approach till the final clearance is received.