EUR 120.00 For Business Accounts Only

MOSL: DIVI'S LABORATORIES (Neutral)-Sales impressive, higher RM cost hurts margins

DIVI'S LABORATORIES: Sales impressive, higher RM cost hurts margins

(DIVI IN, Mkt Cap USD6.3b, CMP INR1687, TP INR1655, 2% Downside, Neutral)

• Highest-ever quarterly revenue run-rate: DIVI's sales were up 9.2% YoY to INR14.5b (our estimate: INR13.5b) in 2QFY20, led by 13% YoY growth in the CRAMS segment (59% of sales) and supported by strong 43% YoY Nutraceutical sales to INR1.6b. However, Customer Synthesis segment grew moderately by 4% YoY (61% of sales), impacting overall growth. Change in the product mix with a shift toward generics (59% v/s 57% YoY) and increased RM cost led to gross margin contraction of 390bp YoY to 59%. DIVI incurred non-recurring operational expense of INR200m related to power & fuel, consultancy and other regulatory costs. Adjusting for this, the EBITDA margin shrank 410bp YoY to 35.3% (our estimate: 34.2%). Accordingly, EBITDA declined 2% YoY to INR5.1b (our estimate: INR4.6b). DIVI had a forex gain of INR132m for the quarter. Adjusting for the same, PAT was down marginally by 1% YoY to INR3.6b (our estimate: INR3.4b). For 1HFY20, sales/EBITDA/PAT grew 12.5%/1.3%/ 1% YoY to INR26b/INR9b/INR6.4b.
• Key highlights: (1) Strong ramp up in Nutraceutical sales led by the start of second-line operations. (2) Inventory build-up is largely to secure RM availability. (3) Backward integration to manufacture key starting materials/intermediates is on track and the benefit would accrue from 4Q. (4) DIVI is progressing well on brownfield expansion with INR2b spent in 1HFY20 and INR9.4b towards CWIP. (5) Post capex, DIVI would take 6-9 months for regulatory validation before beginning commercial operations.
• Valuation and view: We lower our earnings estimate by 5% for FY20 to factor in higher RM cost, impacting profitability over the near term. However, we maintain our FY21 estimates as the benefit of backward integration would accrue gradually 4QFY20 onwards. We roll to 23x (unchanged) 12M forward earnings and arrive at a TP of INR1,655 (prior INR1,590). With the strong chemistry skillset in place, DIVI remains on track to benefit from the CRAMS (contract research and manufacturing services) opportunity. It also on track in terms of capex to cater to future needs of customers, providing visibility of robust growth in earnings. However, the current valuation largely factors in the positives. Maintain Neutral.