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Margin recovers; sales yet to pick up

Work-in-progress for greenfield project at Kakinada

* The operational performance of Divi’s Laboratories (DIVI) missed our estimates marginally in 1QFY24, due to lower sales in generics and custom synthesis. However, EBITDA margin expanded sequentially owing to lower raw material/logistics costs.

* We reduce our earnings estimates for FY24/FY25 by 3%/5% to account for a gradual off-take in custom synthesis/nutraceutical sales in the near term and extended benefits of cost management activities. We value DIVI at 35x 12M forward earnings to arrive at a TP of INR3,430.

* DIVI continued to add capacity for product development/manufacturing and strengthen its capability in the contrast media space as one of the key levers of growth over the next 3-5 years. Further, being a leader in the core generic portfolio with the lowest cost, DIVI is in a good stead to see better growth than the market in respective molecules. However, we maintain our Neutral rating as we believe the valuation adequately factors in the earnings upside over the next two years. It is trading at 15%/48% premium to its 5- year/10-year average PE multiple.

Product mix/lower RM cost drives profitability QoQ

* Revenue declined 21% YoY to INR17.8b (est. INR19.8b).

* Gross margin contracted by 270bp YoY to 61.3% due to a change in the product mix.

* EBITDA margin contracted at a higher rate by 920bp YoY to 28.3% (est. 26.4%) largely due to lower GM and higher employee costs/other expenses (+390bps/260bp as a % of sales). ? As a result, EBITDA was down 41% YoY at INR5b (est. INR5.2b).

* The tax rate was 27.5% in 1QFY24 vs. 17.5%/31.2% in 1QFY23/4QFY23.

* Adjusted for INR30m in forex gains, PAT was down 46% YoY at INR3.6b (est. INR3.9b).

Highlights from the management commentary

* The generics:CS sales ratio was 60:40 for 1QFY24. Nutraceutical sales stood at INR1.8b.

* DIVI continues to work on contrast media API registrations in various geographies. The validations by customers are also underway. DIVI intends to capture the gadolinium-based contrast media opportunity FY25 onward.

* Manufacturing capacity for Unit III would comprise key starting material, nutraceutical APIs, advanced intermediates and certain complex products.

* A decline in logistics cost aided profitability to some extent.

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