Sequential gains in Q4, improving earnings trajectory for Divi's Labs

The stock of Divi’s Laboratories is up 10 per cent over the last couple of trading sessions on expectations that the worst is behind and the company could see a sequential growth in the March quarter of the 2022-23 financial year (Q4FY23). The stock witnessed the highest downgrades among Nifty50 index stocks with earnings cuts over a third after the Q3FY23 results.

The company had posted a 32 per cent drop in revenues over the year ago quarter in Q3FY23 and 8 per cent sequentially, which was sharply lower than Street expectations. The decline was on account of muted custom synthesis business which fell by 54 per cent due to a high Covid-19-related base.

For Q4, while most brokerages expect a year-on-year (YoY) fall, they expect a sequential revenue growth. Vishal Manchanda and Bezad Deboo of Systematix Research point out that the worst is likely behind for Divi’s, which could report sequential mid-single digit revenue growth with margin expansion. The brokerage expects a 4 per cent quarter-on-quarter (QoQ) revenue growth and a 30 per cent fall in revenues as compared to the year ago period. The brokerage has a ‘sell’ rating on the stock.

Kotak Institutional Equities expects a 6.4 per cent growth on a sequential basis while its estimates for YoY growth is pegged at 28 per cent. The sales decline, according to Alankar Garude and Samitinjoy Basak of the brokerage, was due to a high base of anti-viral drug Molnupiravir. While the company posted sales of $95 million in the year ago quarter, it had zero sales of this drug in Q4FY23. Excluding the impact of the one-offs in the base quarter, revenue growth is expected to be flat on a YoY basis.

The other key parameter the Street will track in the Q4 results are margins. The company had posted its worst margin performance till date in Q3FY23.

Gross margins at 57 per cent were down 10 percentage points YoY and 700 basis points (bps) on a sequential basis due to pricing pressures in the generic active pharmaceutical ingredient segment.

Lower contribution from the high margin contract development and manufacturing business, coupled with higher raw material inflation, weighed on its profitability. Negative operating leverage led to 63 per cent fall in operating profit while operating margins came in at 24 per cent.

Brokerages expect a sequential improvement in margins. Gross margins, according to Kotak Institutional Equities, should improve by 340 bps, sequentially, though they will still be down by 660 bps YoY at 60.1 per cent due to lower incremental impact of high cost inventory.  The brokerage has a ‘sell’ rating on the stock.

The margin gains are expected to sustain over the next couple of years. Motilal Oswal Research estimates a 260 bps margin expansion over FY23-FY25, led by reducing cost drag, scale-up of custom synthesis business in contrast media/peptide category, as well as sartans/other new molecules in API business.

Though they expect annual earnings growth of 15 per cent over FY23-25 period, they factor in a flat earnings growth for FY24, partly due to Molnupiravir-related benefits accrued in the first half of FY23 and partly due to gradual improvement in profitability/outlook in the API generics segment.

While earnings growth over the next couple of years is positive, the brokerage has a ‘neutral’ rating, given flat earnings growth for FY24 and lack of valuation comfort.