Divi’s well placed to de­liver more gains

Pric­ing pres­sures for drug mak­ers can lead to more out­sourc­ing

Business Standard - - THE SMART INVESTOR - UJJVAL JAUHARI

Divi’s Lab­o­ra­to­ries is among the few pharma com­pa­nies that have out­per­formed in the last one year with its share price tick­ing up 75 per cent.

Reg­u­la­tory con­cerns re­gard­ing the con­tract re­search and man­u­fac­tur­ing ser­vices (or CRAMS) ma­jor, which get most of its rev­enue from ex­ports, have hurt the Street’s sen­ti­ment. But Divi’s has ini­ti­ated sev­eral mea­sures to re­solve US Food and Drug Ad­min­is­tra­tion (FDA) is­sues.

The com­pany’s Unit II at Vishakha­p­at­nam had re­ceived an im­port alert from the FDA in De­cem­ber 2016. But Divi’s has com­pleted the re­me­di­a­tion in time and re­ceived an es­tab­lish­ment in­spec­tion re­port in 2017.

Hav­ing cleared reg­u­la­tory is­sues, Divi’s is seen well­paced to re­port good growth in FY19. Dur­ing the De­cem­ber 2017 quar­ter, the com­pany’s op­er­at­ing in­come had wit­nessed growth against de­clines in the pre­vi­ous three quar­ters. How­ever, for­eign ex­change losses have af­fected its op­er­at­ing per­for­mance. Since Divi’s will not be spend­ing much on re­me­di­a­tion costs to re­solve reg­u­la­tory is­sues, its op­er­at­ing per­for­mance is ex­pected to get a legup. The com­pany had in­curred re­me­di­a­tion cost of ~140 mil­lion, ac­cord­ing to an­a­lysts, who ex­pect the same to de­cline to ~50-60 mil­lion in Q4 FY18, and be­come nil in FY19. An­a­lysts at Motilal Oswal Se­cu­ri­ties ex­pect Divi’s earn­ings be­fore in­ter­est, tax, de­pre­ci­a­tion and amor­ti­sa­tion (Ebitda) mar­gin to im­prove by 400 ba­sis points to 36 per cent.

Besides, ex­pan­sions at its unit I and unit II will drive growth. Divi’s has in­vested in a new nu­traceu­ti­cals plant and has planned to cap­i­talise an ad­di­tional ~1.75 bil­lion with re­spect to Unit I’s ex­panded ca­pac­i­ties in Q4 FY18. If its Kak­i­nada plant ex­pan­sion, which is fac­ing lit­i­ga­tions, gets an ap­proval, it will add to Divi’s rev­enue vis­i­bil­ity.

How­ever, af­ter res­o­lu­tion of FDA is­sues at Unit II, the Street ex­pects Divi’s other units to face in­spec­tions.

An­a­lysts at Motilal Oswal Se­cu­ri­ties had said Unit I, which ac­counts for 35 per cent of to­tal rev­enue and ex­po­sure to the US, is at 11 per cent of to­tal rev­enue and was last in­spected in June 2014. It will be cru­cial for the com­pany to suc­cess­fully clear the FDA in­spec­tion (par­tic­u­larly be­cause the FDA had cited data in­tegrity is­sues at Unit II).

On the pos­i­tive side, there are im­mense op­por­tu­ni­ties for Divi’s. Pric­ing pres­sure and com­pe­ti­tion for the in­dus­try is ex­pected to in­crease out­sourc­ing op­por­tu­ni­ties for Divi’s, and a sig­nif­i­cant uptick may lead to a re-rat­ing, an­a­lysts said.

Con­sid­er­ing re­me­di­a­tion ex­penses to be on the de­cline and a se­quen­tial im­prove­ment in over­all per­for­mance, an­a­lysts at Phillip Cap­i­tal es­ti­mate Divi’s earn­ings to grow 26 per cent an­nu­ally over FY18-20.

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