Divi's Labs: APIs, custom synthesis, ongoing capex plan to support growth

The near term upside, however, is limited given the sharp stock price run up

The Divi’s Laboratories stock gained 44 per cent over the past month after a record June quarter (Q1) performance and expectations that revenue growth outperformance will continue. In addition to structural tailwinds in active pharmaceutical ingredients (APIs), its relationships with global pharma majors, ongoing capex programme, and strong execution are expected to support growth prospects. 

Its recent gains, however, have been on account of its Q1 performance, which was its best ever. Led by broad-based growth across its three segments of APIs, custom synthesis, and carotenoids, the firm posted a 49 per cent growth in revenues and 78 per cent uptick in operating profit. Backward int­e­­gration, improvement in product mix, and fall in raw material prices led to an over 700 basis poi­nts year-on-year  gain in operating profit margins to 40.5 per cent. 

A key growth trigger for the stock is APIs, which accounts for 51 per cent of sales. Divi’s has leadership in key APIs and a development pipeline that should ensure revenue growth. Analysts at Motilal Oswal Research say large volumes in select products, coupled with an established presence across the value chain of manufacturing APIs, give Divi’s a cost adv­a­ntage, operating leverage, and better terms with its suppliers. With firms looking at alternative sou­rcing destinations to China, the firm could be a key beneficiary. 

The other key segment is custom synthesis, which accounts for 41 per cent of its revenues. While the segment is a high-margin one, it tends to be lumpy. Analysts, however, believe that prospects are improving given the high level of research and development expenditure by global pharma majors, Divi’s research capabilities, and adherence to intellectual property protocols. This should drive revenue growth of 18-20 per cent over the next two years and add to overall profitability. 

Another trigger is the ongoing capex plan, which is in its final phase. The company spent Rs 1,300 crore in FY20. While some of the units were commercialised earlier this year, the expansion is expected to be completed in the current financial year. This will increase volumes, add to its backward integration and help expand margins. The expanded volumes will also help the firm tap the upt­ic­k in demand. 

Analysts say Divi’s has a successful track reco­rd of monetising its capex plan, the ben­efits of which should start flowing to the top line starting FY22. Given the multiple triggers for the stock, Emkay Research expects net profits to double over the FY20-23 period with strong sectoral tailwinds and upcoming capex. 

Further, they add that the stock will continue to trade at a premium to historic valuations. However, the sharp run-up in prices and valuations, which are at 40x its FY22 estimates, factor in some of the gains. With target prices around the Rs 3,500-mark, investors will have to wait for a better entry point.