Divi’s Laboratories Ltd is strategically poised to capitalize on emerging opportunities. Buy for target price Rs 4041: SMIFS

Margin improvement driven by easing of RM prices

Divi’s lab missed the earnings estimate and reported revenue degrowth of 21.2% YoY and 8.9% QoQ to Rs. 17,780 mn. The sequential decline was mainly due to 11% QoQ decline in Generic API business and Custom synthesis business. The gross margins have seen improvement on sequential basis due to softening of raw material prices and improvement in the logistics costs. However, the full impact will be by Q4FY24. EBITDA decreased 41% YoY but has witnessed improvement of 3.4% QoQ to Rs.5,040 Mn due to lower revenue. Due to improvement in logistics and RM costs and visibility of strong revenue growth in FY25 we increase the FY25 revenue, EBITDA PAT estimates by 4.7%/17.4%/17.6% resp.

Custom Synthesis – For Q1FY24, Divi’s 86% of the revenue is from export business, where the export to regulated markets contributed 67% of the total export revenue. The custom synthesis segment, which is a high margin business, accounted for 40% of total revenue, witnessed decline of 30% YoY and 11% QoQ to Rs.7,112 mn. This segment is expected to witness CAGR growth of 15.4% from FY23-FY25E on the back of launch of two fast track projects. Apart from this, there are certain Contrast media projects where the validation is to be completed by Q4FY24 which will contribute to revenue growth in FY24.

Generic – The generic segment accounted for 50% of total revenue. Revenues grew by 6% YoY but has seen decline of 11.2% QoQ to Rs 8,888 mn. The company is expecting that in FY23-FY25 USD, USD 20 bn worth of drugs will be going off patent which will create huge opportunities for APIs companies. The company has allocated an aggressive capex spend of Rs.10-20 Bn (including a greenfield Kakinada factory) overthe FY23 and FY24 to seize these opportunities. The Kakinada plant is expected to be commercialized by end of FY24, which will help Divi’s to supply API’s in huge volume. We expect revenue CAGR of 18.4% from FY23-FY25E from this segment.

Nutraceuticals – This segment witnessed decline of 4% YoY and has seen improvement of 18.6% QoQ basis to Rs. 1,780 Mn.

Margin – The softening of prices of intermediates, solvents, and other raw material prices led to improvement of the gross margin on sequential basis by 373 bps in Q1 FY24 but has seen decline of 269 bps YoY to 61.3%. These margins are sustainable going forward as well. EBITDA margins decreased by ~921 bps YoY but has marginally improved by 335 bps on sequential basis to 28.3% due to significant decrease in logistics costs and other operating expenses (logistics costs have reduced from Rs. 4000 per container to Rs. 2000). Currently, its facilities are operating at 70-80% utilization. Post commercialization of Kakinada plant, several capacities will be free which will help in Debottlenecking. Higher capex spending, launch of new products and volume growth across offerings remain key growth drivers.

Valuation: Divi excels in tailoring synthesis processes for specific segments, showcasing its expertise in custom synthesis. Its remarkable track record of securing recurring high-volume contracts underscores its specialization. As a result, Divi is strategically poised to capitalize on emerging opportunities presented by recently off-patent molecules. Company is seeing softening of RM and logistics costs which will improve the margins further. We forecast Revenue / EBITDA / PAT CAGR during FY23- 25E at 16.7% /31.5%/27.5%. We value the stock based on SOTP valuation strategy and arrive at a target price of INR 4,041. Accumulate.