Earnings downgrade a bitter pill for pharma major Divi's Labs stock

Weak quarterly results make brokerages turn bearish on the stock

Earnings downgrades for pharma major Divi’s Laboratories continue after the company delivered yet another quarter of underwhelming performance. Given the sharp divergence in expectation and the company's operational performance, brokerages have revised their FY25 earnings per share by 6-13 per cent. 

The disappointment for the contract development and manufacturing organisation (CDMO) on the revenue front was on account of the weak show of the generics segment. While overall revenues were up 9 per cent year-on-year (Y-o-Y), they were 3 per cent lower on a sequential basis due to pricing pressures in the generics space. While there is pricing pressure, the company expects the same to stabilise over the next two or three quarters.

Gross margins improved by 313 basis points on a sequential basis to 60.7 per cent, given lower raw material costs and improved product mix. However, despite the gains, the operating profit margins, which improved by 130 basis points sequentially and 250 basis points Y-o-Y at 26.4 per cent, were lower than estimates (28 per cent) due to slower revenue growth and higher operating costs.

Nuvama Research highlights multiple near-term headwinds for the company.

“At a time when generics active pharmaceutical ingredient (API) business is facing pricing challenges, Red Sea disruption adds to its woes and puts pressure on margin. While the situation is likely to persist for longer, a pickup in two Big Pharma custom synthesis projects should provide relief in the near term. Even so, we believe achieving a historical margin of 35–36 per cent would be a tall ask and may take a few more quarters,” says Aashita Jain of the brokerage.

Though there are a couple of growth drivers such as contrast media, complex amino acid products ( glucagon‐like peptide‐1 or GLP-1) and soon-to-expire patented products, success in this remains untested, says the brokerage, which has a reduced rating on the stock given execution risk in new molecules. 

Brokerages such as Elara Capital also point out that margins are still a far cry from the historic 34 per cent plus levels. Despite pricing in a 13 per cent top line growth and expansion of margins from 26-27 per cent to 33 per cent plus over the next two years, the brokerage believes that the stock remains expensive. It has reduced the earnings per share by 6-13 per cent over the next two years and has a sell rating on the scrip.

Motilal Oswal Research has a neutral rating on the stock. The brokerage highlights that Divi’s is progressing well with respect to the CDMO opportunity for GLP-1 products. It is currently showcasing its capabilities to an innovator customer and also has capacity if required for this customer. Further, it is also working to add new molecules in the API segment. However, the brokerage feels that at 48 times its FY25 earnings per share the valuation adequately factors in a 29 per cent annual earnings growth over FY24-26.

The stock, which is down 8 per cent from its January highs, is up about 1.5 per cent post the results. However, given that valuations factor in the expected upsides from new orders, there may not be much upside in the near term.