After a good performance in FY 2022, Divi’s Laboratories Ltd is facing two main problems. One, the gains from the pandemic are set to moderate with an expected decline in sales of the COVID antiviral drug, molnupiravir, whose revenue is included in the company’s Custom Synthesis (CS) business. Divi’s manufactures Generic Active Pharmaceutical Ingredients (APIs) and is also present in the CS segment.
Against this backdrop, some analysts expect FY2023 (FY23) revenue from the CS segment to be lower than the previous year on the back of a higher base. Some of this pain is already visible, with CS revenue falling sequentially in the June quarter (Q1FY23). Management told analysts in a post-earnings call that Divi’s has completed all Molnupiravir orders and is discussing further orders.
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Besides, the overall near-term earnings outlook is muted. “Divi’s two large custom synthesis projects, which are multi-year, will start distribution in commercial quantities only after 1-2 years. Another key growth driver for the company is new generics due to expire between 2023-2025, which are currently valued at $20 billion. In a report on August 15, analysts at Jefferies India said, “There is still at least a year left in the sale of these new generics as the patents have expired.” ) business, which we believe will require more time to make a major financial impact,” the broking firm said.
The generics (excluding nutraceuticals) business, which made up about 39% of Q1 revenue, is improving, but may not compensate on an overall basis. According to Kotak Institutional Equities, “Recovery in generic API is unlikely to help bridge the short selling gap of molnupiravir, resulting in only 2% compound annual growth rate per share in FY 2022-25E.”
Divi’s existing and upcoming capacities will meet the medium term needs. Capacity utilization is 83%. However, the Kakinada project is significant and the delay has affected investor sentiment. The company is still waiting for the land transfer from the Andhra Pradesh government. Barring this project, Divi expects capital expenditure not to exceed 500-600 crores in FY23.
Divi’s second problem is that the margin crisis persists. Surya Patra, an analyst at PhilipsCapital (India) said, “The coming quarters will see margin pressure, which will limit the up-gradation in its earnings estimates.” Divi did well in terms of revenue in the first quarter, but the margin show was nothing to write home about. , with cost pressures and logistical headwinds on profitability. For perspective, earnings before interest, taxes, depreciation and amortization (Ebitda) margin fell to a nine-quarter low of 37.6% in the first quarter. The metric is down 630 basis points (bps) sequentially and 590 bps year-over-year (year-over-year) up a basis point 0.01%.
Shares of Divi are down 5.5% since Friday when Q1 earnings were announced, taking the stock’s year-on-year decline to 20%, as against a 9% fall in the Nifty Pharma index. However, it is not as if the valuation is less demanding. Bloomberg data shows the stock is trading at around 34 times estimated earnings for FY24.
“At a time of supply disruptions from China and when global pharma companies aim to mitigate risks from the Chinese supply chain, Divi’s mid- to long-term prospects look good,” Patra said. Has also signed a contract with a large pharma company in Contrast Media and is expanding into new areas. However, in the near term, triggers for meaningful outperformance in Divi’s stock are few and far between.
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