Divi’s Laboratories: Right prescription

Unlike some of its peers whose facility inspections by the US drug regulator FDA went awry, Hyderabad-based drug maker Divi’s Laboratories did not face the heat. As recently as February 2016, the company reported successful inspection at one of its facilities — Unit-2 at the Chippada plant near Visakhapatnam — by the FDA with no observations. Divi’s other facilities are also compliant with US-FDA and other regulators as well.

The company is on expansion mode through capacity additions. First, expansion at its Visakhapatnam facility can lead to step-up in revenue in the short to medium term. Next, the company’s new facility at Kakinada in Andhra Pradesh is expected to become operational from 2017-18.

The stock currently trades at ₹1,110 and is down 10 per cent from its August 2015 highs. It is available at 27 times its trailing 12-month earnings, almost on par with its three-year average, but at a discount of almost 10 per cent to the S&P BSE Healthcare Index.

Investors with a two- to three-year time horizon can consider taking exposure, given the company’s strong record of regulatory inspections, a healthy balance sheet, operational metrics and growth prospects.

Divi’s, a player in the Contract Research and Manufacturing Services (CRAMS) space, has not been affected as much by the US FDA when compared to companies that are manufacturing and exporting APIs and generics. CRAMS players tend to have higher risk management and control procedures for their processes as they are subject to audit by their clients as well.

The company’s product portfolio comprises two broad segments — generic active pharmaceutical ingredients (APIs) and custom synthesis of APIs. Apart from these, it has presence in nutraceuticals and synthesis of speciality ingredients for its clients.

Two generics, Naproxen (pain management) and Dextromethorphan (cough suppressant) account for around a third of overall revenues. While its custom synthesis is a high-margin business, it depends on offtake from select global pharmaceutical majors.

Almost 90 per cent of its sales are derived from exports, of which three-fourth are to the advanced markets of North America and Europe. Not surprisingly, the firm has a strong focus on compliance, adhering to standard operating practices and cGPM.

The company is expected to spend around ₹750 crore in the next one to two years towards capacity additions, the funding for which is largely expected to come from internal accruals.

While ₹500 crore is likely to be spent for the new plant at Kakinada, the rest may go towards expanding its Visakhapatnam plant.

The company is setting up unit-2 at Visakhapatnam to double generic capacities and for exclusive synthesis of a speciality ingredient for one of its US clients.

Historically, the company has managed to grow its revenue at an average annual rate of around 25 per cent between 2011 and 2016, while operating profits grew at around 20 per cent.

Once these proposed expansion plans are executed, the pace of growth is likely to pick up.

With its plants running at around 90 per cent, there is still scope for increasing capacity utilisation and improving operating leverage.

For the full year 2015-16, sales grew 21 per cent Y-o-Y to ₹3,776 crore, while net profit grew at a stronger 31 per cent to ₹1,112 crore, mainly on the back of lower depreciation. Operating margins though were flat and remained at around 40 per cent.

The custom synthesis order from a multinational pharma company, which commenced in the first quarter of the last fiscal, helped.

Over the years, the company has had minimal debt with most of its capex being funded through internal accruals.