Divi’s Laboratories’ stock has given more than 46 per cent returns in the current fiscal. While the global slowdown continues, contrary to the general fear of contract research activities declining, Divi’s has continued to see upward traction in revenues and profits, primarily led by its strong relationship with customers and low-cost manufacturing model.The rupee depreciation has further boosted its fortunes as around 90 per cent of revenues accrue from exports. Its strong June quarter performance (announced on Saturday) is proof of the pudding following which, on Monday, the stock hit an all-time high of Rs 1,135 before closing at Rs 1,122 on the BSE.
Divi’s prospects remain good, moving forward, too. With all segments growing well, the Vishakhapatnam SEZ is likely to drive revenues and profitability further. The higher tax rates that the company is now seeing are also to be compensated by increased output from the SEZ (enjoying tax benefits). Majority of analysts (32 out of 34) according to Bloomberg data have ‘buy’ rating on the stock with target price ranges of Rs 1,250-1,325 (upside of 11-18 per cent).
All-round growth, robust margins
Divi’s reported a strong 29.7 per cent growth in its revenues led by growth in all its segments. The contract research and manufacturing (CRAMS) business saw revenues at Rs 214.8 crore growing 22.25 per cent. However, the generics (revenue share almost similar to CRAMS) outpaced with sales rising 38 per cent to Rs 232.7 crore year-on-year. Analysts at Karvy Broking observe that strong order flows have led to this outperformance during the quarter. Even the newer neutraceutical segment (Rs 21 crore; includes carotenoids sales) grew by 50 per cent, though on a lower base.
| STRONG GROWTH OUTLOOK | |||
| in Rs crore | Q1’ FY13 | FY13E | FY14E |
| Net sales | 468.4 | 2419.0 | 2974.5 |
| % change y-o-y | 29.7 | 28.0 | 23.0 |
| Ebitda | 190.4 | 909.5 | 1130.3 |
| Ebitda (%) | 40.7 | 37.6 | 38.0 |
| Net profit | 167.4 | 666.6 | 836.7 |
| % change y-o-y | 63.2 | 31.9 | 25.5 |
| EPS (Rs) | 12.6 | 50.2 | 63.0 |
| PE (x) |
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Divi’s surprised the Street on the margin front as well. June 2012 was the second consecutive quarter of Ebitda margins coming at 40 per cent levels, and much higher than 35 per cent seen in earlier quarters and ahead of 35-36 per cent estimated by analysts for the June quarter. Strong pricing power that Divi’s enjoys as well as favourable (high margin) product mix aided margin expansion. Some of it can also be attributed to the rupee’s depreciation.
Also, ramp-up at the Vishakhapatnam SEZ is helping. The SEZ that was started around a year back had higher fixed costs. However, with the ramp-up the fixed costs are being taken care. Analysts at Quant Global Research in their annual report takeaways (last month) had observed that given Divi’s strong competitive advantage, high exports as a percentage of sales and a weak rupee, they expect Ebitda margin (35-40 per cent) to sustain until FY14. Analysts at Motilal Oswal Securities see FY13 Ebitda margins at 37.9 per cent.
Operating profit margins apart, forex gains of Rs 30 crore also helped drive profits in June quarter. Even as effective tax rates remained at more than 21 per cent, net profit at Rs 167 crore thus, jumped 63 per cent year-on-year.
Tax rates may reduce
Even though tax outgo for the June quarter increased 72 per cent, tax rates have been higher since FY12. Analysts observe that the tax rate of Divi’s increased from 9.1 per cent in FY11 to 21.7 per cent in FY12 due to end of tax holiday on export-oriented units (EOU). It stood at 25.5 per cent in June 2012 quarter. However, that could change over the next two years with further ramp up of production at the Vishakhapatnam SEZ unit (from seven per cent of sales in FY12 to 15 per cent in FY13). The unit is eligible for a 50 per cent tax exemption and accounts for around 30 per cent of Divi’s total manufacturing capacity currently.
The road ahead
Divi’s has seen an increase in customer base to more than 300 across businesses (including generics and CRAMS) at the end of FY12. This is positive as the increasing order flows from a widening customer base will help the company sustain revenue growth and secondly, it also reduces the risk to sales, as a change in outsourcing decision of a large customer can meaningfully affect sales.
Further, the Vishakhap-atnam SEZ Unit-II has seen three cGMP inspections during June-July 2012 by TGA Australia (for associated pharma ingredients) and US FDA (for nutraceuticals and APIs or active pharmaceutical ingredients). Analysts say there have been no ‘red flags’ so far and hence, the outcome is likely to be positive. Analysts at Karvy add that the successful completion of the SEZ will enable the company to have flexibility to produce for the regulated markets and sustain growth. Vivek Kumar and Kunal Mishra of SBICaps write in their post results note, “In our view, anticipated FDA nod for DSN facility (Vishakhapatnam SEZ) anytime soon should kick-start fresh supplies to US markets in high margin product mix and hence should drive a re-rating.”
Notably, the company has maintained its FY13 and FY14 revenues growth guidance of 25 per cent, which analysts at Motilal Oswal Securities say will be driven by new contracts for CRAMS and API, as well as ramp-up in neutraceuticals.
