Divi's Labs: Margin boost fails to impress

Divi’s Laboratories performance in March’15 quarter was impressive looking at the margin expansion. Operating profit margins in the December ’14 quarter had disappointed the street. But, at 40.6 per cent for the March’15 quarter it came better than 36 per cent in previous quarter and 37.6 per cent in the year ago period.

The street, however, wasn’t impressed. For one, analysts say, while the strong improvement in margins is welcome, its sustenance will be the key. Also, new triggers for increased pace of growth seem missing. The management’s guidance of 17-20 per cent growth in FY16 as against its earlier guidance of 20 per cent has also led analysts as those at SBI Capital and others to tweak their revenues and earnings guidance for FY16.

The stock, thus, closed just a per cent up at Rs 1,838 on Tuesday. Though most analysts remain positive on the long-term prospects of Divi’s, the gains from hereon appear limited looking at their price targets that range Rs 1,952-2,060 (7-12 per cent upside).

The March’15 quarter growth in margins is being attributed by many analysts to better product-mix, while as those at Emkay Global believe that the sudden jump must have been due to one-off supplies of more profitable ingredients or APIs since revenues remained flat sequentially. Management’s guidance of 37-38 per cent margins in FY16 also indicates that though overall margins will be better than FY15 it may not be as high as seen in the March’15 quarter.

On the business front, Divi’s Custom Synthesis business contributing about 46 per cent to overall revenues grew well marking a year-on-year growth of 15.3 per cent in March’15 quarter to about Rs 380 crore. Analysts expect a steady growth from this segment as the number of product launches in past few years has been stagnant at about 5-6 product launches. For higher growth, the approval rate will be necessary. The management says, the business environment is resuming stability and they have not witnessed any slowdown in orders in the past two quarters. Analysts at Reliance Securities suggest that cash generation will improve once the product launches in this segment picks up, which will be an inflection point for upgrades for the stock.

On the other hand, the generics business grew by just 4 per cent year-on-year to Rs 390 crore. The key to growth will be genericisation of key niche products over the next few years. The generic approvals of mega products as gastro treatment drug Nexium and hypertension drug Micardis are some of the few which can propel this segment’s growth in FY16. Again, faster approvals are crucial.

The carotenoids (nutraceuticals) segment reported a growth of 27.8 per cent year-on-year, albeit on a small base, to Rs 46 crore. For the year, its revenues stood at Rs 170 crore as against management guidance of Rs 180 crore. The management has guided for Rs 220 sales in FY16.