Divi's Labs cash in on bullish sentiment, strong growth prospects

The second largest pharma player by market value is also expanding capacities to push earnings

Divi’s Laboratories, which has gained more than 14 per cent from August lows and trading near all-time highs, has also become the second-largest pharma player by market value. The Street’s high growth expectations from Divi’s CRAMS (contract research and manufacturing services) business comes at a time when generics players in the US are facing the heat of pricing pressure.

With the competitive intensity remaining high, pharmaceutical companies are likely to resort to more outsourcing to control costs, thereby benefiting players like Divi’s that focus on supplying active pharmaceutical ingredients (API) for niche generics. This segment is likely to continue growing, and more so due to Chinese supply constraints. In addition, since the company is regulatory compliant, having resolved all issues with the US Food and Drug Administration (FDA), it is being looked as a safer bet compared to other Indian pharmaceutical peers. To meet the growing demand for its products, it is also undergoing capacity expansions, which will drive growth further.

CRAMS comprised about two-fifth or 40 per cent of the company’s business in FY19. The rising pharma outsourcing trend is not only helping Divi’s sustain strong growth, but the business is margin accretive too compared to one merely supplying generic ingredients. The segment has shown a good recovery on account of an improved business environment, say analysts. Strong R&D capabilities and India cost arbitrage along with IP (intellectual property) adherence are some legacy strengths that will drive incremental assignments from multinational companies, said analysts at ICICI Securities, who expect Divi’s CRAMS segment to grow 10.6 per cent annually to Rs 2,519 crore over FY19-21.

The generic API business has been a larger contributor to the company, at about 58 per cent of overall revenues in FY19. However, Divi’s, as a research-driven company, has always depended and filed for niche ingredient opportunities where the growth opportunities are significant. In fact, the company has selectively filed new drug applications, which stands at 42 DMFs (drug master files) with US FDA, point out analysts. Divi’s enjoys 70 per cent global market share in products such as ingredients of pain control (Naproxen) and a cough suppressant (Dextromethorphan), according to analysts’ data. The company now is working on and expanding its capabilities in various types of carotenoids — another niche segment. Estimates suggest sales from generics will grow about 12 per cent annually over FY19-21. 

To meet growing demand, the company continues to expand capacities. While its Kakinada green-field expansion may still be facing challenges, work on a brownfield SEZ unit at Unit-2 near Visakhapatnam, and another SEZ project at Unit-1 near Hyderabad continue. Analysts say that due to recent supply constraints from China, they expect higher growth in this segment. And, with a focus on brownfield expansion, the Divi’s management is committed to addressing capacity constraints.

However, looking at the ongoing capital expenditure, the management had lowered the operating profit margin guidance for FY20 while maintaining growth guidance of 15 per cent. Analysts say that once the capacity expansions are completed, growth could surpass 20 per cent in FY21. Led by the completion of backward integration projects (for key APIs) and improving product mix, margins too may improve. 

In the near term, for the quarter ending September’19, analysts at Emkay Global expect Divi’s to report strong operating performance sequentially (up 31 per cent with margin expansion of 421 basis points) leading to net profit growing 33 per cent sequentially. The company had seen some disappointment in June quarter due to unfavourable product mix impacting margins. Nevertheless, Purvi Shah at Sharekhan said that long-term growth is likely to remain healthy, led by aggressive capacity expansion plans to monetise opportunities in the US and China.