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Outsourcing to drive growth prospects

Divi’s Laboratories is a major manufacturer of generic active pharmaceutical ingredients (APIs) and is among the best players in the Indian contract research and manufacturing space (CRAMS).

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Divi’s Laboratories is a major manufacturer of generic active pharmaceutical ingredients (APIs) and is among the best players in the Indian contract research and manufacturing space (CRAMS). It has a focussed approach on developing new processes for the production of APIs and intermediates. Concentrating on generic API leadership, Divi’s is expanding its high-margin custom manufacturing (CM) business.

With increased revenue contribution from CM, it is seeking to enter the $1 billion global nutraceutical market. It has achieved the carotenoids synthesis ability, which is among a few in the world, and has started its first capacity for carotenoids this month. With another capacity from the planned SEZ starting contributions in the year and increased contribution from all segments, one can look at increased growth prospects for Divi’s.

Generic APIs & intermediates: Divi’s manufactures APIs for generics. Realising the importance of non-infringement of patents, it follows all norms for IPR compliance. It has established relationships with pharma giants and a focussed approach to regulated and premium markets like US and Europe. It follows a business model, which is complementary to MNCs and generic houses, taking care of competition.

Divi’s provides advanced intermediates for generic APIs that have already gone off-patented as well as for those going off-patent. With tie-ups with both original inventors as well as generic API manufacturers, it utilises business opportunities from all ends.It has attained market leadership in various products like dextromethorphan, phenyleffrine, nabumetone and lopamidol; these products alone contribute 30% to the generic API sales. Strong pipeline of products for developed and controlled markets provides immense future revenue opportunities.

A molecule Levetiracetam offers opportunities for revenue generation this year.
This molecule alone will provide immense sales opportunities as established brand for the molecule has $500 million sales.

Custom manufacturing: Divi’s develops association with the innovators from the discovery stage and thereby capitalises the opportunity of supplying APIs right from the time the molecule gets commercialised. Through its association with most of leading innovators, it earns opportunities for repeat business from these clients. This segment has grown sharply accounting for 50% of sales in FY08.

Carotenoids: Divi’s has successfully developed synthesis of important carotenoids namely beta-carotene, lycopene, astaxanthin, canthaxanthin etc. Synthesis of carotenoids being a complex process, very few players have been able to achieve success, thus limiting competition.

Only two major players BASF and DSM are operating in this segment. Nutraceutical market for carotenoids stands at around $1 billion globally, thereby offering immense opportunities for Divi’s.

The new facility built at a cost of Rs 35 crore started commercial production in June this year. Divi’s will thus see its first year of revenues from this segment. Estimated revenues stand at $10 million in FY09E going up to $20 million in FY10E.
Investment rationale:

Divi’s, in the backdrop of growing outsourcing by global companies and on account of its relationship with innovators, stands to gain handsomely. Divi’s continues its pursuit of leadership in generic APIs with sustained efforts on growing high-margin custom manufacturing business.

Contribution from CM growing to 50% of sales in FY08 adds to the margins of Divi’s. With a chain of products lined up in generic APIs, future revenues from this segment will continue growing exponentially. Looking at the sales of leading brand Keppra at $500 million, generic APIs for Levetiracetam will contribute potentially in the current fiscal year.

The new SEZ, developed at cost of around Rs 170 crore, will become operational this year and start contributing to capacities and revenues from FY09E.

Thus with revenues slated to go up coupled with margin improvements, business prospects for Divi’s are strong.

Concern: With business focus of Divi’s concentrated on the US and Europe, any appreciation of rupee can have negative impact. However, there seems to be limited possibility for any such development in the near future.

Valuation: Divi’s revenues grew 43% in FY08 beating expectations and PAT grew 87% at Rs 350 crore with profit margins at 34%. Tax rate also declined 7% with the effective tax rate for the year being 8%. This was in line with company guidance. Tax rate is slated to stand at 8-10% in FY09E.

Operating margins are to grow with SEZ becoming operational andalso the nutraceutical business. Further gains will be accrued in light of appreciation of dollar and higher billing in dollar would add to margins and revenues from Q1FY09E.

With revenues and margins expected to grow exponentially in the year, business prospects of Divi’s stand strong. The stock, which is available at Rs 1,340.40, trades 25.18 its FY08 earnings and is a good addition to portfolio.

Disclaimer: The writer does not hold any shares of the company.

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