Published on 16/09/2019 11:16:11 AM | Source: Motilal Oswal Services Ltd

Neutral Divi's Laboratories Ltd For Target Rs.1,590 - Motilal Oswal

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Adverse macro situation for raw materials impacts profitability

* Earnings growth moderates on higher raw material costs: 1QFY20 sales grew 17% YoY to INR11.6b (our est. INR13b). The company had healthy growth in the key segments of generics and custom synthesis (CS), driving the overall growth for the quarter. Nutraceutical sales came in at INR1b, growing at a moderate rate of 13% YoY for the quarter. Gross margin contracted 370bp YoY to 61% due to higher share of generics (~59% v/s ~57%) in total sales. Also, the supply disruption, largely due to environmental concerns in China, has elevated cost of raw materials, further impacting gross margin of the company. Other expenses had one-offs due to forex loss of INR61m. Adjusting for the same, EBITDA margin contracted at similar rate of 350bp YoY to 33.8% (our est. 36%). EBITDA at INR4b (our est. INR4.6b) grew 6% YoY. Adj. PAT grew at a moderate rate of 4% YoY to INR2.7b (our est. INR3.4b) due to higher depreciation and tax rate for the quarter.

* Key highlights:

(1) Divi’s Labs is working on backward integration to ensure key starting material availability, the benefit of which would accrue from 2HFY20.

(2) In the interim, inventory has been increased from INR16b to INR18b to secure raw material requirement.

(3) There has been an increase in customers qualifying the company’s Nutraceutical products. Accordingly, the traction in this segment is expected to improve over the medium term.

(4) Divi’s Labs has incurred capex of INR1b in 1QFY20, has Capital Work-In-Progress (CWIP) of INR6.5b and capital advances of INR2b. The company is on track with its estimated total capex of ~INR17b over the next 12-15 months.

* Valuation and view: We lower our earnings estimate by 3% for FY20/FY21 to factor in higher raw material costs over the medium term. We roll to 23x (unchanged) 12M forward earnings and arrive at price target of INR1,590 (unchanged). Divi’s Labs is well placed to benefit from the CRAMS (contract research and manufacturing services) opportunity. With compliance issues now behind, it further provides certainty for earnings growth in the future. However, we maintain Neutral stance, as current valuation adequately factors in the upside in earnings growth over the next 2-3 years.


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