Higher raw material costs, adverse product mix weigh on Divi's Labs

Divi’s Laboratories' March quarter results did not meet the Street’s expectations, leading to a sharp 9.5 per cent correction in the stock on Monday. Though the company’s revenues grew 15.5 per cent year-on-year, they were lower than the Street’s estimates.  

The bigger disappointment came on the profitability front with operating profit margins declining 60 basis points to 34.9 per cent. Analysts at Motilal Oswal Securities had pegged margins to come at 39.6 per cent. This margin performance was significantly lower even though operating profits grew 13 per cent year-on-year.

Higher raw material costs fuelled by the rising Chinese chemical prices were the major reason for margins disappointment. The rising share of generics to overall revenues, too, had some impact (59 per cent now as against 55-56 per cent earlier). Additionally, other expenses remained higher due to a forex loss and the higher allocation to corporate social responsibility.

It was not a surprise then that net profits, which were up 10.6 per cent year-on-year, missed expectations.

Though the March quarter performance was muted, the company is well placed to grow given its client base and the contract research business, which has traditionally been a high margin one. Even though it remains slightly lumpy and the company may have seen higher contributions from generics during the quarter, there are growth triggers given higher competitive intensity in developed markets and cost-control measures adopted by multinational companies (MNCs). 

Strong R&D capabilities and India cost arbitrage, along with IP adherence, are some legacy strengths, which will drive incremental assignments from MNCs, say analysts at ICICI Securities as they expect the CRAMS segment to grow 13.6 per cent annually over FY19-21.

The company is also growing its neutraceuticals segment after having developed various types of carotenoids, including beta-carotene, which given supply constraints from China would act as a positive.

Further, the company is expanding its capacities through brownfield expansions and will see benefits from the same over the next one year. With capex behind and capacity constraints over, additional earnings uptick may come by the second half of FY21. Analysts already expect API generics to grow 13.4 per cent annually over FY19-21.

Thus any correction offers an opportunity for long-term investors.