Divi's Labs: Uncertainties remain despite good Q3

Divi's maintained its FY17 guidance of 15% revenue growth with EBITDA margin of about 38%

Divi's Laboratories' performance in the September-December quarter (which is the third quarter, or Q3), as well as the guidance on growth and margins, gives cause for confidence. The company's revenues grew 13.4 per cent and net profits were up 8.8 per cent as the Ebitda (earnings before interest, taxation, depreciation and amortisation) margin at 39.3 per cent expanded about 170 basis points, on a year-on-year basis, in the third quarter.
 
In the announcement, which came on Saturday, Divi's maintained its FY17 guidance of 15 per cent revenue growth, with the Ebitda margin at about 38 per cent.
 
However, there are concerns at the delay in capacity expansions as well as US Food and Drug Administration-related issues. So, even as the stock, which hit a 30-month low of Rs 672.20 on January 25, has risen about 10 per cent to Rs 740 levels now, further gains could get restricted.
 
In Q3, Divi's continued seeing its largest segment - active pharmaceuticals ingredients (which account for about 57 per cent of the overall revenues) - grow at a good pace (17 per cent year-on-year). The contract research business (about 35 per cent of the revenues) grew at eight per cent. The nutraceuticals segment, though small at six per cent, promises profitability and growth. Analysts at Motilal Oswal Securities say at this rate the company will miss its initial guidance of Rs 250 crore of nutraceuticals sales. They have also cut their EPS (earnings per share) estimates by five-six per cent as they build muted revenue growth due to capacity constraints.
 
There is still no clarity on capacity expansions. Work at the new facilities of Vizag and Kakinada has not started. If the Andhra Pradesh government does not clarify its position on the Kakinada plant, Divi's may look for another site to build its facility. The worrying thing is that it has invested in the Kakinada plant (Rs 50-60 crore, according to analysts). Adding capacity at existing locations can compensate and add to growth to some extent.
 
The biggest concern, however, remains a possible escalation of issues with FDA regarding the second unit of the company. After the inspection in November, Divi's had got five observations from the US drug regulator. This unit contributes about 20 per cent to sales. The company is trying to be FDA-compliant and said it had filed its comprehensive response to the observations in time. While this is positive, if the matter escalates, there can be an EPS downside of about Rs 15 for FY18-19, according to Edelweiss estimates.