Divi's gains on strong core business

Last Updated: Tue, Dec 20, 2011 19:21 hrs

Robust performance in CRAMS segments continues; scale-up of Vizag SEZ and fall in rupee should boost revenues and profits.

In a year when most stocks have suffered losses on bourses, Divi’s Laboratories stands apart with a 16 per cent return. Its outperformance is even more stark, considering the Bombay Stock Exchange Sensex tanked 25.5 per cent during this period. On the operational front, contrary to the general fear of contract research activities declining due to the global slowdown, the company has seen good growth on the back of its strong relationship with customers and a low-cost manufacturing model.

The company is further benefiting from a scale-up in the high-margin carotenoid (nutritive chemicals) segment. Realisations from the Visakhapatnam SEZ that started operations in the June quarter, have also started improving and will see further growth during the second half of 2011-12. Though the fixed costs at the SEZ still remain high, analysts feel the decline in margins is being cushioned by the rupee depreciation.

In fact, the rupee depreciation is bringing larger benefits to Divi’s, compared to the rest of the pharma pack, as it derives more than 90 per cent of its revenues from exports. Analysts say for every one rupee fall in the dollar, Divi’s stands to gain incremental earnings of about four per cent. Thus, the earnings estimates for Divi’s are getting revised on one side due to the rupee depreciation and are helped by the consistent revenue growth in the core business on the other side.

Contract research is picking up
According to analysts at Enam, growth in the contract research and manufacturing services (CRAMS) segment was one of the a major reasons for the 18 per cent growth in the September quarter revenues for pharma companies under their coverage.

Their coverage includes 12 major pharma companies, including Divi’s and Jubilant Healthcare, in the CRAMS universe. Operating profit margins for CRAMS companies grew 501 basis points according to their estimates.

While the overall adjusted profits grew 15 per cent, CRAMS companies saw 47 per cent growth in profits. They say after a long drawn period of inventory rationalisation and slowdown in contract inflows, the outsourcing industry is showing some signs of recovery. With focus on cost control and higher revenue growth forecast, the sector looks attractive at current valuations.

Rs crore H2FY12 FY12E
Earlier est New est Chg (%) Earlier est New est Chg (%)
Rs-$ average rates  45 51 13 45 51 13
Total sales 888 995 12 1,601 1,708 7
Ebitda 348 477 37 620 749 21
Ebitda (%) 39.2 47.9

870 bps

38.7 43.8

510 bps

Net profit 289 395 37 498 603 21
EPS (Rs) 21.8 29.8 37 37.5 45.5 21
Source -Emkay Global research                                                                                                                        E, Est: Estimates

Overall growth continues
During the first half, Divi’s saw 40 per cent growth in revenues at Rs 752 crore. Despite higher fixed expenses at the Visakhapatnam SEZ, its overall expenditure grew 38.6 per cent annually, enabling a faster increase of 42 per cent in operating profit. However, a sharp rise in tax outgo restricted net profit growth to 31 per cent (Rs 209 crore), which was still strong. The SEZ’s contribution is expected to grow faster in the second half and analysts at Bank of America Merrill-Lynch see it growing to Rs 400-500 crore in two years. They estimate the high-margin carotenoid business growing almost threefold from Rs 62 crore in 2010-11 to Rs 160 crore by 2012-13.

Analysts at MF Global believe Divi’s is best placed to benefit from the global pharmaceutical outsourcing opportunity, given its relationships (with customers) and India-based low-cost manufacturing model. Divi’s enjoys strong relationships with large innovators (18 of the top 20 players) and a leadership position in several active pharma ingredients, input for finished products.

Surya Narayan Patra at Systematix expects Divi’s to maintain its steady progress in the medium and long-term, led by gradual improvement in the global pharma outsourcing segment. He adds drugs worth $225 billion going off-patent during 2011-15 will lead to ample opportunities for Divi’s and a ramp-up in its carotenoid business will drive revenues further.

Depreciating rupee a bonus
The depreciating rupee has added to the positives for the stock, as 91 per cent of Divi’s revenues come from exports. The company, with no forex liability, is likely to see a better second half, compared to the first six months. Emkay analysts Deepak Malik, Ashish Thavkar and Bhavita Nagrani, in their recent report, increased their second-half revenue estimates for Divi’s by seven per cent and annual estimates by 12 per cent. They say since the company has not taken any forward covers, rupee depreciation will lead to their earnings before interest, taxes, depreciation, and amortisation, as well as earnings estimates for Divi’s increasing by 37 per cent for the second half and 21 per cent for 2011-12. Thus, net profit and earnings are estimated at Rs 395 crore and Rs 29.8 per share for the second half, and Rs 603.2 crore and Rs 45.5 per share, respectively for 2011-12.

Considering the positives, more than 80 per cent of analysts remain positive on the stock. Patra at Systematix estimates Divi’s earnings to grow at a compounded annual growth rate of 20 per cent over FY11-13. The one-year target price for the stock trading at Rs 743 as per Bloomberg data stands at Rs 902, which translates to a 21 per cent upside from the current levels. At current levels, the stock trades at 20 times FY12 and 16.2 times FY13 consensus earnings estimates, respectively.

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