Analysts caution against bottom fishing in Divi's

Strong observations by US FDA for Unit II facility, accounts for 70% of the company's revenues

The Divi’s Laboratories stock fell 22% on Friday to Rs 866 after more clarity emerged on observations by the US Food and Drug Administration (USFDA) for its unit-II facility at Visakhapatnam. The USFDA puts its inspection report in Form 483 that deals with violations of various regulations. In Divi’s case, the USFDA’s report of its inspection from November 29 to December 6 had five observations, of which four were serious. 

Why the investors sold the stock was because unit-II — that includes export-oriented facility, pharma special economic zone (SEZ) and the DSN SEZ (its second SEZ unit) — accounts for 70% of Divi’s Lab’s overall business and 75% of its overall capacity, according to Praful Bohra of Religare Institutional Equities. While the US accounted for 32% of (direct) sales from this unit in FY16, including indirect sales (intermediaries outside the US, who source from Divi’s and export to the US), this number could be half of Divi’s revenues. Divi’s 

is in the process of expanding this facility at a cost of Rs 250 crore. 

The observations, according to analysts, are negative and serious, especially the fifth observation, which says the documents and records were not maintained, or were inaccurate or falsified. Data integrity is a key issue and any slippage on this count requires a longer time frame to settle. 

Ranbaxy is a major example, where the company falsified data and its key plants were put on import alert. What is surprising is that the same unit of Divi’s was cleared without observations by the USFDA in February. The subjective nature of the inspections and extent of observations vary depending on the inspectors that probably account for the wide divergence in the reports, analysts say.

Divi’s will now have to respond to the USFDA observations within 15 days. The company is required to come up with a remediation plan. If the USFDA is not happy with the remediation, then it can escalate the issue. If this happens, the USFDA can issue a warning letter or in the worst case scenario, an import alert that would mean the company wouldn’t be able to export its products to the US. 

Though the stock has corrected steeply, analysts say investors should not bottom fish, as the current observations could escalate into a more strict action that would mean a much larger downside, given the plant’s significant contribution. Even if the company is able to sort out the issues, analysts say investors will be cautious, and it will take a while for sentiment around the stock to pick up.