Divi's looks to US injection of hope

Prospects appear bright with the management having forecast 20-25% sales growth in FY15

The Divi's Laboratories stock on Tuesday spurted five per cent intraday on the back of a good December quarter show which saw the company beat expectations across all parameters. The stock closed with gains of 2.3 per cent at the end of trading. The company, which declared its results after market hours on Monday, posted a revenue growth of 29 per cent and net profit growth of 52 per cent. The revenues came on the back of higher volumes across its segments. Revenue growth is expected to improve in the March quarter, while a further boost will come after the approval of its DSN unit at Visakhapatnam by the US Food and Drug Administration (FDA). The key risk is any delay or adverse comment by the USFDA could hurt growth rates. Meanwhile, the company has forecast a sales growth of 20 per cent in FY14 and 20-25 per cent in FY15.

While most analysts are positive on the long-term story, given its low-cost leadership, economies of scale, top pharma clients and research capabilities, a few are cautious after the recent run-up in the share prices. The stock is up 40 per cent since October on expectations of a USFDA approval and volume gains, benefits from a weakening rupee (Divi's gets 90 per cent of its revenues from exports) and lower costs.

At Rs 1,344, it is trading at 20 times its FY15 earnings estimates. Say Praful Bohra and Sumit Singhania of Nirmal Bang Institutional Equities Research, "We remain structurally positive following its recent capex, but after the run-up over six months (up 42 per cent against a six per cent rise in the Nifty), we believe it captures the near-term upside. As a result, we have downgraded our rating to hold from buy. The USFDA continues to be the key trigger."

After the results, of the 13 analysts polled by Bloomberg, 11 have a buy, one hold and one sell, with an average target of Rs 1,523. While the potential upside is 13 per cent, investors should await a correction for a good entry point.

Strong top line, margin growth
Aided by a strong volume growth in generics (41 per cent year-on-year) and custom synthesis businesses (17 per cent year-on-year) as well as favourable currency movement, the topline grew 29 per cent year-on-year to Rs 687 crore. Generics and custom synthesis each account for half of revenues. Improving utilisation of the DSN unit is expected to drive growth. The USFDA has inspected two of Divi's five units, with the other three expected to be inspected in three-four months.

With the power situation improving in Andhra Pradesh, margins have improved. Power costs fell 200 basis points year-on-year and 160 basis points sequentially. Lower power expenses, cost rationalisation, currency gains and a better product mix helped earnings before interest, taxes, depreciation and amortisation (Ebitda) margins jump 760 basis points year-on-year to 41.6 per cent. Positively, the management has guided for an Ebitda margin of 40 per cent for FY15.

Strong operating performance and lower tax rate helped the net profit grow 52 per cent to Rs 220 crore even as other income fell to Rs 8 crore compared from Rs 22 crore a year ago. Though Divi's reported a 39 per cent growth in earnings per share for the first nine months of FY14, cash generation remained weak with net cash at Rs 340 crore at the end of December 2013 against Rs 410 crore in FY2013. The weak cash generation, according to Kotak Institutional Equities analysts, has been primarily due to higher capital expenditure at Rs 250 crore for the first nine months of FY14. The company has forecast a Rs 350-crore capex for FY14, higher than the forecast of Rs 200 crore at the end of the September quarter. Given the better-than-expected results, A Jayakumar of Elara Capital has revised upwards his earnings estimate for Divi's five per cent and two per cent for FY14 and FY15, respectively.