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Custom Synthesis drives earnings

Promising outlook, with superior execution, bodes well for company

* Divi’s Lab (DIVI) delivered a strong beat on 3QFY22 earnings, led by healthy growth across the Custom Synthesis (CS), API, and Nutraceutical businesses. DIVI continues its efforts in strengthening its chemistry skill set and manufacturing capacity for COVID / non-COVID business.

* We raise our FY22E earnings by 8% to factor in a higher off-take in the CS segment. We maintain our earnings estimate for FY23/FY24 as we await further clarity on the sustainability of COVID-related opportunities over the next couple of years. That said, we expect a 23% earnings CAGR over FY22– 24E, led by increased traction from new and existing customers in CS and favorable demand for products in the API segment. We value DIVI at 36x 12M forward earnings to arrive at TP of INR5,500 and maintain a BUY rating.

* We remain positive on DIVI as it is well-placed to benefit from a) the opportunity arising from formulators increasingly outsourcing to Indian companies, b) DIVI’s readiness to timely address prospects arising from the COVID/non-COVID situation, c) new product introductions, as well as d) market share gains in existing products in the API segment.

Highest ever sales/EBITDA/PAT quarterly run-rate

* Divi’s Lab posted revenue growth of 46.5% YoY to INR24.9b (our est: INR22.2b) for the quarter.

* The gross margin contracted 240bp YoY to 66.6%.

* However, the EBITDA margin expanded 150bp YoY to 44.1% (our est: 42.2%) due to lower employee costs / other expenses (-190bp/-200bps as a % of sales).

* EBITDA was up 51% YoY to INR11b (our est: INR9.4b) for the quarter.

* Adjusted for INR31m in forex losses, PAT grew at a higher rate of 83% YoY to INR9.1b (our est: INR7b), led by a lower tax rate of 12.7% in 3QFY22 (v/s 26.7% in 3QFY21).

Highlights from management commentary

* DIVI capitalized INR2b in 3QYF22 and anticipates another INR1b in 4QYF22. The capital work in progress (CWIP) stands at INR4.5b.

* Land for the Kakinada project would shortly be handed to DIVI from the government agency. Subsequently, DIVI would commence its capex program on the Kakinada land.

* It had cash of INR23b at end-3QFY22. It can comfortably incur INR10b towards capex annually for the next 2–3 years for the expansion of existing facilities / greenfield projects.

* DIVI has sufficient capacity to undertake dynamic projects in the case that there is demand for products in the API /CRAMS space, including COVIDrelated products.

* DIVI’s business split between Generics and Custom Synthesis stood at 40%:60%, respectively, in 3QFY22.

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