Multiple near-term concerns trigger Divi's Laboratories' headache

Pfizer's oral Covid drug, weak sales of generics, and valuations may cap upsides

The second-largest pharmaceutical stock by market capitalisation — Divi’s Laboratories — has shed 7 per cent since its results earlier this month. The drop was on worries related to the introduction of Pfizer’s anti-Covid oral drug and its impact on Divi’s revenues, weak show of its generics business in the September quarter, and expensive valuations.

The negative stock reaction has been triggered by the announcement by US drug giant Pfizer on November 5 that its easy-to-administer Covid pill, used in combination with a widely used HIV drug, cuts the risk of hospitalisation or death by 89 per cent in adults who have been exposed to the novel coronavirus.

This is similar to the game-changing Covid antiviral pill jointly developed by US-based Merck and Ridgeback Biotherapeutics and approved by the UK on November 4. The Merck drug called Molnupiravir reduces the risk of hospitalisation or death by 50 per cent for patients with mild to moderate Covid, according to the company.

If the Pfizer drug is approved, it will dent Divi’s revenues since it has a supply arrangement for the active pharmaceutical ingredient (API) for the drug made by Merck. The Street had been building in upsides from the deal with Merck into Divi’s revenues and earnings.

HSBC Global Research had estimated the supply opportunity at $53 million (or Rs 392 crore) for 2021-22 (FY22) and $44 million (or Rs 325 crore) for 2022-23 (FY23) from this product. The company had highlighted there had been some sales of Molnupiravir in the quarter and that it had enough capacity to supply relevant quantities to Merck. The overall oral antiviral Covid market is pegged at $70 billion.

The company posted a slightly lower-than-expected revenue performance in the September quarter. While the overall revenue was 14 per cent higher year-on-year, led by custom synthesis (up 42 per cent), the same was offset by weakness in generics (down 5 per cent).

Motilal Oswal Research has reduced its FY22 and FY23 earnings estimates by 2-5 per cent to factor in moderation in generic API prospects over the near to medium term and increased operating expenditure related to expanded capacity.

The revival of the segment will be driven by market share increase in existing molecules by backward integration and new molecule additions from Divi’s pipeline of 16 molecules in various stages of development.

While the near-term growth driver is expected to be Molnupiravir, where sales offtake is unclear, long-term growth drivers for the company include capacity expansion in established products, new products where patents will expire over the next two to five years, market share gains in existing products, sartans, and iodine-based contrast media products. This will drive 17 per cent growth over FY21-24 for the company, according to Kotak Institutional Equities.

After a dip in prices, the stock is trading at 44.6x its FY23 earnings estimates. Analysts at Kotak Research say the valuations fully capture the superior growth in APIs, while ignoring the risks to the synthesis segment over the long term. Investors should await clarity from Molnupiravir and uptick in generics before considering the stock.