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We reduce our FY25E/FY26E EPS estimates by ~10%. Divi’s Laboratories (DIVI) Q3FY24 EBITDA was 11% below our estimate led by lower margins and generic API sales. GMs improved led by better product mix however OPM are still below pre COVID levels. Mgmt. suggested that moderation of raw material prices with commencement of some CDMO and contrast media contracts, will continue to aid revenues and margins. However, recovery will be gradual and near-term growth is likely to remain muted. We expect 25% EBITDA CAGR and 23% PAT CAGR over FY24-26E. At CMP, stock is trading at expensive valuations of 42x FY26E EPS. Maintain ‘Reduce’ rating with TP of Rs3,150/share, valuing at 35x FY26E EPS as we roll forward. Any sharp recovery in margin is key risk to our call.

* Revenues miss by lower generic API sales: DIVI’s Q3FY24 sales came in at Rs18.6bn (up 9% YoY); lower than our estimates of Rs19.2bn. Generic revenues came at Rs8.4bn; down 2% YoY while custom synthesis (CS) delivered strong growth; up 25% YoY. During Q3FY24 EU and US contributed 71% of revenue. Product mix for generics and custom synthesis in Q3FY24 were at 54% and 46% of revenue. Nutraceutical business for the quarter was at Rs1.53bn, decline of 5% YoY.

* Another quarter of weak margins: GM came in at 60.7%; up 300 bps QoQ on account of change in product mix. Employee expenses grew by 12% YoY, while other expenses increased by 15% YoY. Resultant EBITDA came in at Rs 4.9bn (up 20% YoY and 2% QoQ) vs our estimate of Rs5.5bn. OPM came in at 26.4%, up 130bps QoQ; below our estimate of 28.5%. Margins are still below pre COIVD levels. There was a forex gain of Rs 180mn during the quarter. PAT came in lower at Rs3.6bn; 7% below our estimate.

*  Key concall takeaways: Generic Business: Stable demand for established products. Expanded capacities for both large and small molecules; have gain market share in most of its key molecules. Pricing pressure still persists and expect to stabilize over next 2-3 quarters. Kakinada Unit: Invested Rs 4.5bn till date. Utilized 200 acres of land for current block; total land parcel 500 acres. Commercialization to start from Q3FY25, pending regulatory approval. Nutraceutical segment: Anticipates double-digit growth. Company is trying to qualify certain other Iodine-based generic CM products as well. Custom synthesis: The two major products which are under patent continue to witnessed ramp up. Actively involved in peptide building blocks for anti-diabetic and anti-obesity drugs. Divis will produce amino-acids for same. GLP-1 Opportunity: Sufficient capacity to meet initial demand; products patent-protected. This will start contributing from FY25. Capacity utilization was at 80%. Cash stands at Rs39.1bn. Guided for double digit revenue growth. Red Sea crisis will lead to increase in freight costs.

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