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Short-term hiccups in margin; outlook remains intact

* DIVI delivered an in-line earnings in 1QFY23. While traction in Custom Synthesis (CS) has toned down in 1QFY23, there has been a pick-up in the sale of Nutraceuticals. Also, the completion of additional capacity will drive a better sales run-rate in the Generics segment

* We cut our FY23/FY24 EPS estimate by 6%/3% to factor in: a) a higher operating cost due to an inflation-linked increase in raw material cost and elevated freight cost, and b) some moderation in the CS segment. We continue to value DIVI at 33x 12M forward earnings to arrive at our TP of INR4,340.

* While the high base in FY22 may cap earnings growth in the near term, DIVI continues to strengthen its skill sets in newer technology like peptides, HiPo conjugate drugs, and contrast media products. It is also building up its commercial capability to tap future business opportunities. We maintain our Buy rating.

Higher sales growth was outweighed by lower profitability on a YoY basis

* Revenues grew 15% YoY to INR22.5b (est. INR22.1b) in 1QFY23.

* Gross margin (GM) contracted by 330bp YoY to 64% due to the change in the segmental mix.

* EBITDA margin contracted at a higher rate by 590bp YoY to 37.6% (est. 40.6%) largely due to lower GM and higher other expenses (up 300bp as a percentage of sales).

* As a result, EBITDA was flat YoY at INR8.5b (est. INR9b) in 1QFY23.

* Adjusted for INR564m in forex gains, PAT rose 3% YoY to INR6.6b (est. INR6.7b) due to a lower tax rate in 1QFY23

Highlights from the management commentary

* The management reiterated its EBITDA margin guidance of 40%, including other income, for FY23

* With capacity expansion in the Generics segment in place, it expects sales to pick up going forward

* One of the capacity expansion projects, related to CS, is complete

* DIVI had a Generics-to-CS share of 47:53 in 1QFY23.

* It garnered sales of INR1.9b in the Nutraceuticals segment in 1QFY23

* CWIP stands at INR5b. The management expects capital expenditure of not more than INR5-6b in FY23, unless the Kakinada project kick starts

* DIVI is working towards peptide chemistry and HiPo conjugate drug-related technology, which will drive opportunities over the next three-to-four years.

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