Divis Laboratories on strong growth trend, experts expect margins to expand

Strong demand for active ingredients is further accentuated by shortages even as prospects in custom synthesis business remain firm

Divis Laboratories is trading near its all-time high and has returned about 38 per cent to investors in the last six months. The firm remains an exporter of generic active pharmaceutical ingredients (about 56 per cent of FY18 revenues) and custom synthesis (CRAMS, about 44 per cent of FY18 revenues). It has continued to benefit from strong demand for both.

Demand for the ingredients is further helped by Chinese supply constraints, favourable currency movement, and certain product shortages in the US market. The custom synthesis business prospects also remain firm, considering the increased competitive intensity from global pharmaceutical firms that are resorting to cost-cutting measures and thus increasing the outsourcing component. 

Analysts expect the custom synthesis business to grow 17-18 per cent annually over FY18-21. While the custom synthesis business is margin-accretive, analysts also feel that growth prospects in the pharma ingredients business are equally strong. 

Analysts at ICICI Securities expect sales from generics segment (including carotenoids) to grow at 18.3 annually over FY18-21. Due to increased visibility for orders from innovators and the generic business, Divis is on track to spend a large capex on its two special economic zone (SEZ) units over the next 2-3 years despite delay in its Kakinada greenfield expansion.

The company remains committed to a few research-driven niche opportunities and is increasing its presence in another niche area of carotenoids after acquiring requisite capabilities. 

It has developed various types of carotenoids, including beta-carotene, the largest in the group.

Divis, for the first nine months of FY19, has seen 32 per cent year-on-year revenue growth and operating margins, too, have expanded to 39 per cent (up 760 basis points year-on-year) due to improvement in gross margins and favourable operating leverage.

Analysts expect the momentum to continue and with reduction in remediation-related cost, profitability should improve. Divis had successfully resolved issues raised by the US Food and Drug Administration (USFDA). 

Analysts at Motilal Oswal Securities see the company’s margins expanding to 39.6 per cent in the March quarter and they expect net profit to grow at a higher rate by 54 per cent year-on-year on the back of better revenue growth, margin expansion and reduced tax rates. 

However, while growth prospects remain strong, the stock is trading at about 28 times FY20 earnings estimates. It isn’t cheap in terms of valuation and investors could consider it after a correction.