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Custom synthesis drives earnings

Work in progress to enhance peptide opportunity

* Divi’s Lab (DIVI) delivered lower-than-estimated earnings in 3QFY24. Its custom synthesis (CS) business has witnessed revival during the quarter, aided by two major contracts with innovator. However, its API business continues to be impacted by reduced pricing. The pricing effect was marginally offset by higher volume off-take.

* We cut our estimates by 7%/4%/4% for FY24/FY25/FY26, factoring in a) pricing pressure in API segment, b) subdued performance in nutraceutical segment, and c) scope of increased freight costs due to the Red Sea issue. We value DIVI at 36x 12M forward earnings to arrive at a TP of INR3,440.

* DIVI is progressing well with respect to the CDMO opportunity for GLP-1 products. It is currently showcasing its capabilities to an innovator customer and also has capacity if required for this customer. Further, it is also working to add new molecules in API segment. However, at 48x FY25E EPS of INR77 and 39x FY26E EPS of INR94, we believe the valuation adequately factors in a 29% earnings CAGR over FY24-26. Maintain Neutral.

Segment mix benefit offset by lower operating leverage to some extent

* DIVI’s 3QFY24 revenues grew 9% YoY to INR18.5b (our est: INR20.3b).

* The revenue share of generics/CDMO stood at 54%/46% in 3QFY24. CS grew 25% YoY to INR8.5b, while generics/nutraceuticals declined 2%/4% YoY to INR8.5b/INR1.5b.

* Gross margin expanded 400bp YoY/210bp QoQ to 60.7% due to a change in product mix. The QoQ improvement in gross margin was led by increased business from CS segment and lower raw material costs.

* However, EBITDA margin expanded at a lower rate by 250bp YoY to 26.4% (our est: 27.8%), largely due to higher gross margin, which was offset by higher employee costs/other expenses (+40bp/110bp as % of sales).

* As a result, EBITDA grew 20% YoY to INR4.9b (our est: INR5.6b).

* Adjusted for INR180m in forex gains, PAT grew 26% YoY to INR3.4b (our est: INR4b).

* In 9MFY24, revenue/EBITDA/PAT declined 5%/21%/25% YoY to INR55.4b/ INR14.9b/INR10.6b. Moreover, EBITDA margin declined 540bp YoY to 26.9%.

Highlights from the management commentary

* 3QFY24 included certain business from two major contracts from an innovator customer, which boosted CS segment growth. DIVI expects this business to scale up in the coming quarters. The products are under patent and thus provide good visibility for the business.

* DIVI has the capability to develop protected amino acids and is working with innovators to improve business prospects.

* DIVI has a capacity that can be allocated for GLP1 products after qualification by customers.

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