Growth and margin uptick critical for gains in Divi's Laboratories

The September-quarter (second quarter of financial year 2023-24, or Q2FY24) performance of Divi’s Laboratories fell short of analyst expectations, especially on the profitability metric. Rise in input costs, inventory write-off, and pricing pressures led to a drop in gross margins. Higher competitive pressures led to cuts in operating profit margins and earnings estimates for FY24 and FY25. Most brokerages have a ‘neutral’ or a ‘reduce’ rating on the stock on account of valuations.
 

Divi’s overall revenues grew 2.2 per cent year-on-year (Y-o-Y), dragged down by the custom synthesis (CS) segment, which was down 4 per cent due to the higher Covid-19 base. Its generic business grew 5 per cent on the back of a double-digit volume growth. However, what offset the strong volumes was a single-digit price erosion.
 

In addition to backward integration for existing products, the company is also building a portfolio that includes products with upcoming patent expirations within the next 2-3 years, says Motilal Oswal Research. Drugs going off-patent in the FY23-26 period are pegged at $20 billion. While the CS decline was on account of no Covid-19 (Molnupiravir) sales, excluding this like-to-like growth was at 48 per cent Y-o-Y. 

 

The growth was primarily driven by incremental sales from the hypertension drug Sacubitril and contrast media. The company has guided for an enhanced ramp up in contrast media products starting Q3, and has built a pipeline of contrast media products with a global target market of $5 billion. This provides a near to mid-term growth visibility, says PhillipCapital Research.
 

On the profitability front, operating profit margins dipped 740 basis points to 26.1 per cent on account of lower gross margins and higher employee costs as well as other expenses. IIFL Research expects further margin headwinds going ahead. With a large part of incremental growth expected to come from the contrast media segment and generic drug master files (including Sartans), Divi’s margins could continue to remain under pressure and below historical levels, given these segments are inherently lower-margin businesses as compared to the CS segment. Analysts led by Rahul Jeewani and Naman Bagrecha of the brokerage have cut their FY24-26 operating profit by 2-9 per cent and maintained a ‘reduce’ rating. They believe that one year forward valuations (price-to-earnings) at 50 times leaves no scope for disappointment, considering that a 25 per cent annual earnings growth is already built over the H1FY24-FY26 period. 
 

Prabhudas Lilladher Research, too, has a ‘reduce’ rating as it expects recovery to be gradual and near-term growth to be muted. While operating and net profit growth is expected to be at 14-16 per cent annually, it finds that valuations are on the expensive side.
 

Motilal Oswal Research is factoring in 25 per cent net profit growth annually over FY23-25, adjusting for Covid-led business in FY23. This is on the back of improved visibility for contracts in the custom synthesis segment as well as ramp-up in products in contrast media space. Analysts led by Tushar Manudhane believe that the current valuation adequately factors the upside in the earnings and thus has a ‘neutral’ rating.