Near-term upsides capped for Divis Labs

Though the June quarter show was above expectations, the company cut margin forecast for FY17

The Divis Laboratories stock hit a 52-week high this week, as the company maintained its FY16 revenue forecast of 15 per cent. Its June quarter's results also beat estimates on all fronts. The stock has gained 12 per cent over the past four trading sessions.

Led by the generic and custom synthesis business segments, the company's revenues in June quarter grew 24.6 per cent over a year to Rs 1,008 crore. The performance of generic business, accounts for 56 per cent of revenues, was better than expectations. Company realisations improved six per cent over a year due to currency benefit, while volumes are estimated to have grown 19 per cent, according to analysts at Religare Institutional Research. However, the currency moves is critical, as nearly three quarters of the company's revenues are exposed to forex movements and the company keeps its exposure unhedged.

While revenue performance was better than estimates by about seven per cent, it was the operating level show, especially margins, which was the major surprise. Overall margins, expanded 280 basis points (bps) over a year to 40 per cent, were 300 bps above what analysts' estimate. Margins were better on account of lower input costs and better product mix. Raw material costs as a percentage of sales were 140 bps lower at 38.2 per cent. While operating performance was strong (operating profit up 34 per cent to Rs 403 crore), net profit was up 23 per cent to Rs 302 crore due to higher taxes.

Despite a strong June quarter, the company has maintained its FY17 revenue growth forecast (and did not raise it upwards) at 15 per cent due to a delay in capacity expansion. All its plants currently are at full utilisation rate, and new facilities in Vizag and Kakinada, are delayed and likely to come through only in FY18. Further, the company has cut margin forecast by 50-100 bps for FY17 Vs flat margin forecast given earlier. The lower forecast is to account for the Rs 79-crore one time ex-gratia payment to employees. Analysts estimate the FY17 margins to be around the 37 per cent. While the company is on a strong footing, given supply agreements and research & development, there is little upside for the stock in the near term, given recent run-up. HSBC analysts have a 'hold' rating, citing no near-term visible catalysts.