Divi's Labs: Margins the only blip in an otherwise spectacular Q2

Higher Diovan generic contribution led to lower margins

Despite a strong performance in the September quarter, Divi's Laboratories’ stock fell 3.6 per cent to Rs 1,805. This can be attributed to some disappointment on the margins and also profit-booking in the counter, after the over 50 per cent gains since the stock had seen its closing lows of Rs 1,233 on June 5 this year. Over a year, the stock had doubled to Rs 1,871 on October 31, a day before the announcement of its results.

The push to the stock price came with anti-hypertensive brand Diovan generics, launched by Ranbaxy on exclusivity. Divi's remains a supplier of generics to Ranbaxy. For Divi's, Diovan has been a big contributor to its generics business growth. The benefits of the same are evident as Divi's revenues beat Bloomberg consensus estimates by 18.8 per cent. But, while profits and Ebitda (earnings before interest, tax, depreciation and amortisation) were also ahead of estimates, the beat was lower at 13 per cent and 10 per cent, respectively.

On the back of generic supplies to Ranbaxy, generic contribution to overall sales of Divi's increased to 54 per cent while Custom Synthesis' (a relatively higher margin business) share came at 46 per cent. Thus, overall Ebitda margins at 36.8 per cent in the September 2014 quarter came lower compared to 43.9 per cent in the year-ago quarter. Analysts at HSBC say a margin at 36.8 per cent, 330 basis points lower than their estimates, also imply that Diovan generic margins are low for Divi's. The same is also justified by the fact that Ranbaxy's margins came higher than their estimates led by higher Diovan generic margins. However, as far as Divi's is concerned, a lower-than-expected margin for Diovan generic business has brought some disappointment.

Moving forward, too, as exclusivity of Ranbaxy for Diovan continues in December'14 quarter, Divi's will continue to benefit. However, now, the Street is not factoring in very strong margins. Also, post the six month period when exclusivity of Ranbaxy ends, increasing competition will lead to pricing pressure. Analysts say Divi's continues to maintain a conservative 20 per cent sales growth forecast for FY15, with margins close to the first half level of 37 per cent. Thus, while analysts at HSBC have lowered their rating to 'neutral', consensus price estimates of Rs 1,878 as per analysts polled by Bloomberg post results suggests that the stock is fairly priced for now.