>DIVI'S LABORATORIES LIMITED (FIRST GLOBAL)

Healthy growth prospects and ‘above industry average’ margins & return ratios warrant higher multiples…

Re-rating to continue…

What happened last quarter
Divi’s Laboratories Ltd. (DIVI.IN/DIVI.BO) delivered an overall decent performance in Q4 FY09, with the reported numbers for the quarter coming in moderately ahead of our expectations. The standalone topline for the full year FY09 was up 15% Y-o-Y to Rs.11.9 bn, which was moderately higher than our estimate of Rs.11.5 bn, while the net earnings at Rs.4.24 bn, up 20% Y-o-Y, was also 2% higher than our estimate of Rs.4.15 bn. The expansion of 70 basis points Y-o-Y in the EBIDTA margin would have been higher, but for a forex loss of Rs.460 mn included under ‘Other expenses’ in FY09. The company incurred forex losses of around Rs.90 mn in FY08. On excluding these forex losses, the EBIDTA margin for FY09 came in at 45%, up around 370 basis points Y-o-Y. Thus, Divi’s managed to maintain its ‘above industry average’ margins in FY09, despite the current subdued market conditions.

In view of the global economic slowdown, Divi’s does expect some pressure on its Custom Chemical Synthesis (CCS) business and has guided for a topline and bottom line growth of 10-15% for FY10. Nevertheless, the company expects the situation to normalise in FY11 and expects a topline and bottom line growth of 20-25% for the year. In view of the company’s moderately better than expected performance in FY09, we are marginally raising our FY10 revenue and EPS estimates from Rs.13.3 bn and Rs.74.17 to Rs.13.7 bn and Rs.75.87 respectively. For FY11, we estimate an EPS of Rs.95.31, marking healthy earnings CAGR of 20% for the FY08-FY11E period. The stock currently trades at 15.7x our FY10E earnings, which is almost in line with the industry average P/E of 15-16x. In view of its healthy growth prospects and ‘above industry average’ margins and return ratios, the stock deserves to trade at higher multiples. Divi’s’ FY09 EBIDTA margin of 45% (excluding forex losses) and return ratios in the range of 39-42% are still the best among the CRAMS players, as well as in comparison to those of its Pharma peers. We maintain our ‘Outperform’ recommendation on Divi’s.

Outlook
Carotenoids, which were launched in June 2008, brought in sales of merely around Rs.200 mn in
FY09, as against the earlier expectation of about Rs.350-400 mn. Thus, the uptake of Carotenoids in FY09 was slower than expected. However, the company expects a ramp up in FY10. Also, sales of Peptides have been picking up and contributed to around 3-4% of Divi’s’ total revenues in FY09. The company’s cumulative API filings stood at 30 in FY09, as against 28 at the end of FY08. On account of the current market conditions as well as the slower than expected uptake of the CCS business, management now expects a growth of 10-15% Y-o-Y in FY10, though it expects the business to normalise in FY11 and has guided for a growth of
20-25% in the topline and bottom line for the year. For FY10, we now estimate an earnings growth of 15% Y-o-Y and 26% Y-o-Y for FY11. For FY10, Divi’s is banking on API sales of Leviracetam, Iopamidol, and Nabumetone, which will help offset the likely moderate slowdown expected in the CCS business and facilitate a decent topline and bottomline growth of 15%. Overall, we now expect healthy earnings CAGR of 20% for the FY08-11E period. Also, management has been quite efficient in maintaining the EBIDT margin at 40%+, which remains among the best in the Indian Pharma space. In view of the company’s decent growth prospects and ‘above industry average’ margins and return ratios, the stock deserves to trade at higher multiples. Hence, we believe that the stock’s re-rating should continue.

Quarterly Results Analysis (Standalone)
• Divi’s ended FY09 on a decent note, with the topline up 15% Y-o-Y to Rs.11.9 bn and coming in 3% ahead of our estimate of Rs.11.5 bn. The CCS and API businesses now contribute 50:50 to the topline, as against a 40:50 mix in FY08.

• The bottom line at Rs.4.24 bn was up 20% Y-o-Y and 2% higher than our estimate of Rs.4.15 bn.

• The expansion of 70 basis points Y-o-Y in the EBIDTA margin would have been higher, but for a forex loss of Rs.460 mn included under ‘Other expenses’ for FY09. The company incurred forex losses of around Rs.90 mn in FY08, excluding which, the EBIDTA margin for FY09 came in at 45% and was up around 370 basis points Y-o-Y. Thus, Divi’s managed to maintain its ‘above industry average’ margins, despite the current subdued market conditions.

• Carotenoids, which were launched in June 2008, brought in sales of merely around Rs.200
mn in FY09, as against the earlier expectation of about Rs.350-400 mn. Thus, the uptake of Carotenoids in FY09 was slower than expected. However, with the Nutraceuticals facility being commissioned, sales of Carotenoids are expected to ramp up in FY10.

• Peptide sales are also gradually picking up and accounted for 3-4% of the company’s total revenues in FY09 and a further ramp up is expected in FY10.

• Also, API sales from key drugs, such as Leviracetam, Iopamidol, and Nabumetone are expected in FY10. Hence, in spite of some pressure expected on the CCS business (on account of the current subdued market conditions), Divi’s expects a topline and bottom line growth of 10-15% in FY10, on the back of a decent API performance and the ramp up expected from the Carotenoids and Peptide businesses. With the market conditions expected to normalise in FY11, Divi’s expects the growth of the CCS business to remain on track and has guided for a topline and bottom line growth of 20-25% for FY11. The company expectsto maintain its EBIDTA margin at 40%+, going forward.

• In FY09, Divi’s incurred a capital expenditure of Rs.1.41 bn towards capacity augmentation at its manufacturing facilities. The company’s SEZ and EOU units at Visakhapatnam were inspected by the US FDA in FY09.

• In FY09, Divi’s commissioned its Nutraceuticals manufacturing facility, which has commenced commercial operations. The facility, with a state-of-the art beadlet technology, is the first of its kind to be set up in India. The company has fully developed several application products, some of which are being marketed commercially through its subsidiaries in the US and Europe, as well as directly. With the qualifications from new customers, the company’s Nutraceuticals manufacturing facility is expected to ramp up its operations.

• Divi’s has invested its surplus funds in the short-term liquid ultra short-term fund of SBI Mutual fund and its total investments, as of March 31, 2009, amounted to Rs.1.72 bn.

• The company expects to incur an overall Capex of Rs.600 mn for the full year FY10.

• Currently, Divi’s has cash and cash investments of about Rs.2.75 bn, which will be utilised to fund its Capex and working capital requirements.

• The company has foreign currency denominated loans of Rs.470 mn and its total outstanding
loans, as of March 31, 2009, stood at Rs.490 mn.

Price Target
Price targets (if any) are derived from a subjective and/or quantitative analysis of financial and nonfinancial data of the concerned company using a combination of P/E, P/Sales, earnings growth, and its stock price history.

The risks that may impede achievement of the price target/investment thesis are –

• Setbacks on the clinical research front/pipeline setbacks
• Slower than expected uptake of the CCS business
• Inability to bring in strong sales from carotenoids and peptides
• Litigation setbacks

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