API shortage from China an opportunity for Divi’s

Niche capabilities and no regulatory overhang among key positives

Divi’s Laboratories has been consistently gaining, and is up more than 39 per cent since August lows. Trading near its 52-week high now, the company’s stock has not only outperformed the healthcare index, but also the leading indices.

The reason: In the pharmaceuticals space, while Divi’s remains better placed compared to many peers because of good growth and absence of regulatory overhang, it will also benefit from the expected shortfall in supply of APIS (active pharmaceutical ingredients) from China on the back of the coronavirus outbreak, as it is among the leading manufacturers of this raw material.

The API segment makes up about half of the overall sales of the company. The sharp rise in API prices recently (as much as 80 per cent according to analysts) is bound to benefit players such as Divi’s.

However, the company is expected to log gains not only in the short term, but also in the longer term. In order to avoid disruptions, companies globally are evaluating alternative sources for the procurement of APIS, and this is likely to be a key positive for Divi’s, say analysts.

Analysts also see the company benefitting on account of its backward integration, aggressive capex plan (incurred and continuing), and outsourcing opportunities in CRAMS (contract research and manufacturing services).

The company remains committed to only a few research-driven niche opportunities for which it has US Food and Drug Administration approvals. This also ensures good margins. Recently, Divi’s has been increasing its presence in another niche product segment, Carotenoids (nutraceuticals) which are high-margin products too.

Among API players, Divi’s seems to be a winner as it recently commissioned a ~225-crore intermediate facility. Further, it will commence a significant portion of the ongoing capex of ~1,200 crore in the March quarter. The full impact of the same is likely to be reflected in FY21, say analysts at Sharekhan, who also expect further expansion in its margins.

Divi’s, thus, should be relatively better off in case of a disruption in the supply of intermediate, and benefit from higher API prices, say analysts at Emkay Global.

The government is also in the process of charting a road map to boost API production, which should benefit players such as Divi’s. In this backdrop, the analysts at Sharekhan expect 24 per cent annual growth in Divi’s earnings during FY20-22.