Divi's Laboratories: Margins likely to remain subdued, say analysts

Margins to get better once supplies start from expanded capacities next year

Divi’s Laboratories has been one of the biggest gainers among the pharma pack since the start of April. The stock, which has gained 29 per cent, continues to trade near its 52-week high. The Street’s confidence was not misplaced as the company reported a steady March quarter performance. While revenue grew 9.7 per cent, the rise in net profit was sharper at 33 per cent year-on-year. However, the bottom line was also supported by lower taxes and forex gains.

The company reported improved gross margins led by better product mix, lower input costs and backward integration benefits for some critical raw materials. Operating costs, however, increased due to partial commissioning of Hyderabad and Visakhapat-nam brownfield projects.

Going ahead, the company is expected to be a major beneficiary of the rising contract research and manufacturing opportunities, given its strength in manufacturing niche chemical products.

Divi’s expects to complete the ongoing brownfield expansions at a capex of Rs 1,200 crore by the second half of FY21. The company would then need to apply for regulatory approvals of its new capacities for regulated markets such as the US and Europe.

 

 

For non-regulated markets, the company has started commercial supplies from brownfield projects in February and March which should soon translate into revenues.

While the expansions would drive future growth, rising costs could cap margin expansions in the interim. Analysts at Edelweiss Research expect FY21 margins to remain subdued as postoperative fixed costs for newly commissioned capacities are set to hit profit, while approvals for developed markets are yet to come in.

While the company has not given a revenue and margin guidance, the management indicated that high gross margins may not sustain going ahead.

Further, the disruption caused by Covid-19 could extend the timeline of expansions.

Analysts at Motilal Oswal Financial Services have reduced their FY21 earnings estimate, factoring in the Covid-led headwinds over the near term.

After an over 60 per cent rally in the past one year, analysts expect a pause as valuations factor in most positives. Analysts at HSBC, who have a hold rating on the stock, believe sales and margin expansion will come about once the supplies to the US and EU from brownfield plants start in FY22.