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Divi’s Laboratories’ (DIVI IN) Q3FY24 revenue and EBITDA missed our estimates by 13% and 28%, respectively. Revenue grew just 8.6% YoY. EBITDA margin improved 250bps YoY and 130bps QoQ, but was still a far cry from the historic 34%+ levels, recovery to which the stock is pricing in, in our view.

No visibility of a major step-up in earnings

DIVI management continued to refer to several opportunities in the CDMO segment – Some already started and contributing and some that may start in the next few quarters. However, we could not get any confidence on a meaningful step-jump in earnings, as regards the quantum that the stock is pricing in. While the GLP-1 agonist opportunity is big, currently DIVI is mulling only entering the market for basic amino acids that are KSMs for manufacturing long chain peptides. Only 3-4 Chinese players are present in that market currently. Per our back-of-the-envelope calculations, this may not significantly alter our growth projection of low-mid teen growth in the next 2-3 years.

Building in recovery in next two years; high risk of miss

We are building in significant recovery in growth and margins over the next two years. Our projections assume 13% topline growth and expansion of EBITDA margin from the current 26-27% to 33%+. Despite that, the stock is expensive on our numbers. We see high risks to achieving these numbers, unless some big CDMO contract kicks off and starts contributing to growth in a big way. It is worth noting that DIVI’s FY15-23 topline CAGR was only 8.3% in USD and 12.1% in INR terms.

Valuations: Maintain Sell; TP raised to INR 3,017

We reduce FY24E/25E core EPS by 6-13%, but maintain FY26E estimates. The stock trades at 53.1x FY25E core EPS. We reiterate SELL. We raise our TP from INR 2,443 to INR 3,017, which is 35x (earlier 28x) FY26E core EPS plus cash per share, reflecting the higher valuations in the sector. Any unforeseen large product opportunity in the custom synthesis business is the key upside risk to our call.

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