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Yet another consistent quarter despite industry headwinds

Building ‘growth engines’ for sustainable earnings momentum

* Divi’s Labs (DIVI) delivered in-line 1QFY22 earnings, led by strong off-take in the Custom Synthesis (CS) segment. The backward integration efforts over the past 2–3 years have fructified at a time when peers are facing issues in terms of raw material and logistics cost increases. In fact, this has led to better profitability for the quarter. DIVI remains well poised in terms of both product development and manufacturing capacity to sustain superior return ratios over the next 4–5 years.

* We raise our EPS estimate by 5%/4% for FY22/FY23 factoring in a) operational efficiency, b) higher business opportunities in the Sartans portfolio, and c) enhanced growth prospects in the CS segment. We continue to value DIVI at 36x 12M forward earnings to arrive at Target Price of INR5,750. We remain positive on DIVI on the back of a) its strong chemistry skill sets driving opportunities in the CS/Generics segment and b) continued cost reduction in production driving market share and profitability. Reiterate Buy.

Exceeds previous high of revenue / EBITDA margin on quarterly basis

* Revenues grew 13% YoY to INR19.6b (our est: INR19.9b) for the quarter.

* The gross margin expanded 420bp YoY to 67.2%. This was largely owing to a superior product mix and lower raw material costs.

* The EBITDA margin expanded at a lower rate of 300bp YoY to 43.5% (our est: 40.9%) due to higher employee costs (+60bps as a percentage of sales) and other expenses (+60bps as a percentage of sales)

* EBITDA was up 22% to INR8.5b (our est: INR8.1b) for the quarter YoY.

* Adjusted for INR196m in forex gains, PAT grew at a lower rate of 13% YoY to INR5.4b (our est: INR5.7b), weighed by a higher tax rate of 31.6% in 1QFY22 (v/s 25.6% in 1QFY21).

Highlights from management commentary

* DIVI has highlighted six growth engines over the next 4–5 years:

* It would cater to industry-level demand in molecules, wherein it is already leading in terms of market share.

* Manufacturing efficiency would drive market share in molecules, wherein it has 20–30% market share currently.

* Successful backward integration and tackling impurity issues would bring better business opportunities in the Sartans space.

* It has increased traction in Contrast Media in the CS and existing Generics API segment.

* It would scale up two CS projects in addition to Molnupiravir.

* There are potential opportunities from the genericization of products over FY23–25.

* DIVI expects 10–15% YoY growth in revenue in FY22.

* The second stream of the Molnupiravir project has commenced commercial supply and a third stream is now ready to supply commercial quantities. DIVI is fully backward integrated in the Molnupiravir API.

Valuation and view

* We raise our EPS estimate by 5%/4% for FY22/FY23.

* We expect a 34% earnings CAGR over FY21–23E, led by increased business prospects from CS and Generics, improved growth in Nutraceuticals, new product additions in the Contrast Media space, and ~230bp margin expansion on process and productivity improvements.

* We continue to value DIVI at 36x 12M forward earnings to arrive at TP of INR5,750.

* We reiterate BUY, supported by a) a ramp-up in existing products and continued growth in legacy products, coupled with market leadership, b) continued momentum in the CS segment, with chemistry expertise and long-term relationships with innovators, c) an improving outlook for Nutraceutical, supported by higher capacity, and d) cost leadership through process and technological improvements.

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