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Divi's Labs: Healthy show despite cost hurdles

Even as power costs are likely to remain elevated, higher operating leverage at its new SEZ should result in better margins in FY13

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Divi’s Laboratories fell nearly 8% intraday on Monday post September quarter results that were marginally below expectations and lower sales growth guidance by the management. The bulk drugs and intermediates contract manufacturer posted revenues of Rs 470 crore (up 33%) slightly below what analysts expected. The management also projected a sales growth of 20-25% as compared to 25% plus earlier. analysts say that the September quarter results failed to impress the Street due to high power costs which were at 18% of sales as compared to 15% in the previous quarter and low utilisation levels of the company’s new at Visakhapatnam.

However, most analysts have a ‘buy’ on the stock (it has gained 50% over the last year) as they believe sales momentum is likely to be maintained going ahead on the back of higher capacities and the stock is likely to maintain its premium valuations. Says Deepak Malik of Emkay Global Financial Services, "Divi’s continues to maintain strong performance in the CRAMS space vis-à-vis its peers. Best in class margins and return profile (Return on Invested Capital of over 30%), strong balance sheet (near zero debt), India centric assets coupled with positive cash flow provides incremental comfort to investors.” Analysts have pegged a target price in the range Rs 1,250-Rs 1,400. After the initial fall, the stock recovered some ground. Though it is still down 4% (to Rs 1,138 levels) in two sessions, it is trading at 18 times its estimated FY14 earnings, which is at a discount (12%) to its historic valuations.

Eyeing healthy growth

The company’s forecast of 20-25% for FY13 is backed by growth across the customer synthesis and generics active pharmaceutical ingredient (API) segments, which analysts believe looks sustainable in the medium-term. DSP Merrill Lynch analysts Arvind Bothra and S Arun say that the company is likely to attain a 20-25% revenue growth over the next 6-8 quarters on the back of strong visibility from key clients supported by contribution from the new Vizag SEZ facility. The unit’s contribution, which was at 5% in FY12, is likely to go up to 20% in FY14 as will its utilisation, which stands at 30% currently.

Steady margins

The company recorded margins of 39% (up 335 basis points year-on-year) aided by better product mix, despite high fuel costs. Power costs increased by Rs 15 crore as Divi’s had to buy from the grid at a higher price due to power crisis in Andhra Pradesh. However, going ahead, while power costs are likely to increase, BoAML analysts say their margin assumption at 38% (FY12 margins 37%) is not at risk as higher utilisation at Vizag SEZ would drive operating leverage.

At the net level, profit growth at 11% to Rs 120 crore was lower than estimates due to a Rs 21 crore . Adjusted for this, net profit was up 26%. Analysts believe earnings are likely to grow annually by 20% over FY12-14.

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