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Divi's Laboratories' quarterly earnings fell below our projections across all metrics. The reported revenue of INR 18.bn indicated an 8.6% YoY growth but a 2.8% QoQ degrowth, the YoY growth was influenced by market dynamics. The constant currency growth stood at 7%. EBITDA increased to INR 4.8bn, reflecting a 19.8% YoY growth and a 2.1% QoQ increase, with the EBITDA margin reaching 26.4%. This margin expansion of 245bps YoY and 127bps QoQ was driven by a slight decline in raw material prices. The product mix for generics to custom synthesis was reported at 54% and 46% for the quarter.

Custom Synthesis (46% of revenue): CDMO segment is experiencing significant growth, especially with two major projects from prominent pharmaceutical companies transitioning into full-scale production. The contribution from this segment is anticipated to further increase in the upcoming quarters. The company currently has numerous molecules at different regulatory stages with its clients, and with expanded production capacity for both large and small volume products, it is well-prepared for new opportunities. The company is actively engaged in the production of peptide building blocks, particularly for emerging anti-diabetic and antiobesity drugs, showcasing a strategic focus on developing this specialized portfolio.

* Generic (54% of revenue): The company's generic business remains stable, driven by substantial demand for its established products. Anticipating growth beyond FY25, the company expects contributions from recently filed products to play a significant role. Capacity expansions in various molecules are expected to drive this growth. In the nutraceuticals segment, the company foresees double-digit growth. Additionally, efforts are underway to qualify certain other Iodine-based generic Contract Manufacturing products.

* Margin performance: The company witnessed a notable growth in gross and EBITDA margins, with a 401bps and 245bps YoY increase, respectively. This improvement was fueled by a slight decline in raw material prices and a favorable product mix. Despite the potential impact of the red sea crisis on logistics and supply chain costs in the short term, the company remains vigilant. It has fortified its position with a resilient supply base, streamlined inventory management, and the implementation of various adaptive strategies to navigate through challenges effectively.

Outlook & Valuation: We maintain our positive view on Divi’s Lab based on the following factors: 1) Growth in custom synthesis business driven by big projects from big pharma companies as well as good opportunities in the GLP-1 as well as nutraceuticals, resumption of sartans growth which is now in top segments; 2) Iodine based contrast media to sustain growth and gadolinium to contribute from FY25; and 3) Margin improvement due to lowering of RM prices and increased utilisation level. We value the stock based on the SOTP valuation strategy on FY26E and arrive at a target price of INR 4,077 and recommend ADD rating on the stock.

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